Tea with Matthew Seah: Margin of safety.

Matthew shares with us a simple and important concept to invest more safely:

The intrinsic value of a company could be calculated base on our estimations of various aspects of the business, both tangible and intangible. Hence one would require to look at both qualitative and quantitative aspects of the business in order to give a more holistic valuation of a company.

Company valuation can be done using 2 broad types of valuation models:
- absolute valuation; and
- relative valuation.

Absolute valuation is a valuation method that give you an absolute value to compare against the current market price. Absolute valuation method is broadly termed as a discounted “cash flow” method. The different models calculates future cash flows -- dividend (Discounted Dividend Model), free cash flow (Discounted Free Cash Flow Model), operating cash flow (Discounted Operating Cash Flow Model), residual income (Discounted Residual Income Model), etc -- and discount these future values to present value.

Relative valuation is a valuation method that compares certain metrics -- price to earnings ratio (P/E), price to book ratio (P/B), price to sales ratio (PSR), total enterprise value to earnings before interest, tax, depreciation and amortisation (TEV/EBITDA), etc -- against the industry or market average.

Each of these valuation models, including those not mentioned, have their pros and cons. 

Do note that even with complete knowledge of the business, company valuation is still an estimation of what the value of the organisation as other external factors such as macro trends and policy changes in the future is difficult to predict.

So how to overcome this miscalculation?

Introducing Margin of Safety. 

The concept of margin of safety originated from Benjamin Graham and he wrote about it in the very last chapter of The Intelligent Investor (Chapter 20: “Margin of Safety” as the Central Concept of Investment).

Simply put, when market price is below your estimation of the intrinsic value, the difference is the margin of safety. The lower the market price of the stock, the more undervalued it is, and the greater the margin of safety. In essence, the risk of losing money is lower when buying an undervalued company with a large margin of safety.

“A margin of safety is achieved when securities are purchased at prices sufficiently below underlying value to allow for human error, bad luck, or extreme volatility in a complex, unpredictable and rapidly changing world.” 
- Seth Klarman

Margin of safety doesn't guarantee a successful investment, but it does provide room for error in an our judgment when calculating the value of a company.

Related post:
3 points to note in investing.

This condo investment has been a drag.

Is cash flow sufficient to service debt?





Reader:
Hello AK, I read many of your interesting articles on your blog on financial matters. 

I would greatly appreciate some advice to manage my finances. 

I turned 55 and am still working. 

I live in a 3 room HDB flat fully paid for. 





I purchased a 2-bedder private condo in the east for investment purpose and renting it out since mid 2015. 

The rental is covering my mortgage loan but the other expenses such as property tax, home/fire insurance and maintenance/sinking fund amount to $7000 (a year). 

I am thinking of letting go this property...

AK:
If you are concerned with investing for income to fund your retirement, it seems that this condo is more a drain than a pump. 

If the home loan is going to be paid up soon, then, less to worry about. 

If the home loan has another 10 years (or more) to go, at 55 years old, I might be worried.





Know your motivations and you will know if something is the right tool for you.

Related post:
Buy a condo or stocks?

Don't have to sell HDB flat and buy 2 condos to improve cash flow. (Have a fully paid HDB flat and make money.)

A friend told me he is seriously considering selling his fully paid 5 room HDB flat in RCR to buy 2 shoebox apartments so that he could stay in one and rent out the other for cash flow. 

Hopefully, property prices would go up and he could benefit from capital gain by selling one.





I told him that he would be moving from being debt free to being indebted. 

There is no guarantee that the monthly rental could cover the mortgage payments (plus the much higher monthly maintenance and property tax of a condo).




He says he just wants to make money but how sure is he that he would make money this way? 

I see a strong speculative flavour in his hope that property prices would go up. 

I told him if he thinks property prices would double in 10 years like it did in the recent past, that is speculation.




1.
I told him that if he wants money in the pocket, just rent out 2 bedrooms in his current flat. 

Free cash flow guaranteed. Easy. 

To that, he said that it is very hard to rent out the spare rooms now. 

Oh, and he thinks renting out a shoebox apartment is going to be easier? Duh.





2.
I also told him that if he didn't want to share his home with strangers, he could think about downsizing his current flat to a 3 room flat and he would have more money in the pocket. 

Since his current flat is his first, he could get a BTO 3 room flat. 

It is much cheaper than buying resale.

Or maybe a BTO 2 room flat? 

Price tag? $90,000 maybe. 

So cheap hor?
Purchasing a 2-Room BTO flat








A BTO 2 room flat? Serious? 

Alamak, he was thinking about buying a shoebox apartment to stay in. 

How big do you think a shoebox apartment is?

Of course, he might have to wait a few years but he would be able to pocket a few hundred thousand dollars in price difference. 

Also, he would be getting a fresh 99 years lease. 




3.
Then, there is also the option of looking into HDB's sale of balance flats which would reduce the waiting time.

With the price difference of his old and new flats, he could invest for income and it could even be in the form of a shoebox apartment that he is thinking about once he has served his MOP.

There is no need to always take on more risk in life to have a better life. 





I like to have my cake and eat it too but I don't like to choke on my cake.

Oh, in case you are wondering, he got the idea to sell his 5 room flat to buy 2 shoebox apartments from someone. 

Guess what that someone does for a living?

So clever! Bad AK! Bad AK!





Related posts:
1. Power to be financially stronger.
2. Retirement funding and HDB flats.

5 minutes and less than a dollar? Perfect.

Have you ever had a craving for some food which you have never liked before? 

OK, I know the ladies who have been pregnant before might have experienced this but what about us guys?

Well, I have never enjoyed porridge much. 

So, being on a low carbohydrate diet, it is one thing I do not miss. 





However, whenever I am feeling unwell, I seem to crave porridge. 

I don't know why it is so.

When I told a friend I have been having porridge recently, he asked what about my low carb diet? 

When I told him I have been preparing porridge without using rice, he was dumbfounded.

His expression was priceless and I thought my porridge recipe might be blog worthy.

.





Heat up some frozen fried chicken, frozen cooked vegetables (carrots, broccoli and cauliflower) in a microwave oven. 800 watts, 3 minutes. 

Then, put them in a blender with some hot water.

Blend and we get this. Porridge.

I added some black pepper for taste and also a spoonful of olive oil so that the meal keeps me full longer.

Sedap!





Time taken to prepare the meal? 

5 minutes or so.

Cost? 

Probably less than a dollar.

Add an egg if you like.

Cost?

Probably still less than a dollar.





What did you say? 

Spend 5 hours preparing the perfect bowl of porridge?

Hey, do you think I am really mental? 

OK, don't answer that.





Related post:
How to recession proof your life?

How to get things we need or want for free forever?

Eight out of twelve young Singaporeans have yet to plan for their golden years.

A reader asked on Facebook what was the point of the blog which I posted last evening?

Alamak. AK is a mental blogger lah.

Most of the time, he is just talking nonsense. Crazy fellow.

I like to think that everyone's life can be better and it should be better if we have been prudent with money and if we have not been too unlucky in life.

I also like to get things I need and want for free. If I can get someone else to pay for things I need or want in life (legally and ethically), I would.



Regular readers might remember that I said I invested in QAF because I want free bread. Old Chang Kee? I want free curry puffs.

So, what about investing in NTUC Income for income? I want to have some life insurance coverage for free.

Of course, don't take what I say literally but you get the idea.

The writing is on the wall.
Related post:
Dividend for FY 2016 and for life.

Dividend for FY 2016 and for life is a waste of time?

MY BANK ACCOUNT by Tian Long. ROFL!

Most of us are not born with a silver spoon in our mouth. We have to find our own way in life and, hopefully, we do not end up in hole full of snakes or spikes.

Snakes are natural while spikes are man made. Yes, there are people out there who are hunting other people.

We have to learn and avoid such holes.

How to get rich quick? Don't ask me.

How to get rich slow? See this?

Yes, it is something I am reminded of on a yearly basis.

This is money I stashed away donkey years ago and till this day, I am still enjoying the benefits.

I have probably taken back all my money and if the company continues to do well, I will continue to receive some pocket money on a yearly basis.

Of course, on its own, it is not a lot of money but if we focus on the absolute sum, we miss the point.

"Aiyoh, I can only invest $5,000. 6% is only $300 a year. So little. Don't bother lah. Waste time lah."

Continue saying something like that and, all else being equal, really, don't bother thinking about a comfortable retirement. Waste time lah.
Related posts:
1. Secret to AK's success.
2. Investing in INCOME for income.

Hock Lian Seng should be 69c a share.

Reader:
A senior of mine at work told me about your blog when we chatted about stocks. I mentioned Hock Lian Seng and he said AK blogged about it. I bought this because my broker told me it was worth at least 69c and that there was a special dividend. I paid 62c but the price has plunged. I wonder if I should hold or sell or buy more. If you are wondering, I just started investing this year and I don't know who to trust now.

AK:

Trust yourself. Trust no one else, not even AK. I have nothing against your broker and I think I know which brokerage he is from but don't trust him either.

Don't rely on others for investment tips. Buying something because it was a hot tip could end up burning you. 






You have to have an idea of what you are looking at and how much it is worth. Only then would you have an idea if the price makes sense. 

If the price doesn't make sense, is it because it is too cheap or too expensive? Then, you know what to do.






Having said this, as investors, we cannot expect a 100% hit rate. If we can be right more often than we are wrong, we should be happy. 

Sometimes, we can do all the research we could possibly do, be reasonably confident and still be wrong. The only one who is always right is Mr. Market.





You might be interested in this blog post and pay attention to the broker's recommendation:
http://singaporeanstocksinvestor.blogspot.sg/2017/01/history-with-sabana-reit-and-current.html

Those who bought then and bought more as the price declined would be bleeding badly.





If you are not prepared to do some work as an investor, it is better for you to stay away from the stock market.
Related post:
Hock Lian Seng returns more than 100%.

Old Chang Kee recorded a big loss in Q4.

I received a small handful of messages regarding Old Chang Kee's latest results and this is a quick blog about the matter.

Old Chang Kee is a fantastic cash flow generating machine and it remains one of my better although smaller investments. I have no intention to let go of my investment because nothing has changed.

Of course, when I saw the article in The Business Times declaring a huge loss for Old Chang Kee in Q4, I took notice. I spent one minute looking at the financial statement and decided that all is well.

One minute? Yes, only one minute.

I just looked at the income statement to see what has changed. Noticing a spike in expenses, especially other expenses, I scrolled down to find the reasons for the spike.

What I was looking for was whether the spike was going to be material and whether it was going to be enduring in nature. Some of the increase in expenses will continue to be challenging. Labour cost. Rental cost. You get the idea.

However, most of the increase in expenses comes from a revaluation loss which is a non cash item. Non cash item does not affect cash flow. So, unruffled, I went back to gaming.

To be investors, we should pick up some basic knowledge about accounting. Leave the more complicated stuff to the professionals but we should have some basic knowledge.

Financial statement:
http://oldchangkee.listedcompany.com/newsroom/20170529_174958_5ML_AYW9SB1XWVC26BOD.1.pdf

Related posts:
1. Income Statement.
2. Recommended books.

Still making money in Croesus Retail Trust. Peace.

Hi AK,

I wrote to you a few months ago and told you a prominent blogger sold all his investment in Croesus. I asked you if you would be selling too. You gave me one of your typical AK answers. Now, a few months later, I am kicking myself because I sold half of my investment since I was not sure if I should stay fully invested. It was my biggest investment. If I had your conviction, I would have avoided this loss...

Hi R,

I have the feeling that you might not have understood the investment enough to give you the conviction to hold on to a substantial position in Croesus Retail Trust.

Your position could have been too big and peace of mind eluded you.

Money not made is not the same as money lost. By holding on to half of your original investment, you are still making money. Lesser by half but you are still making money.




Peace of mind is priceless. By reducing your investment by 50% when you did, know it or not, that was what you were after. 

Now, please don't lose something precious like this by saying you should not have sold.

Best wishes,
AK
Related post:
History with Croesus Retail Trust.

Accordia Golf Trust and lower DPU.

Reader:
Hey AK, what do you make of Accordia Golf Trust latest results? Looks pretty dismal, all important numbers are down. Any positives to it at all?

AK:
eh... you say leh?

Reader:
From the numbers I don't see anything good. But management says that tourism may have a positive impact in mid to long term
And they said there was bad weather, maybe the weather might improve. That's about all the good I could see from the report

AK:
I would ask if the dip in results is due to something more enduring.
If so, the decline would become a trend.

Reader:
True. But difficult to say how much is due to earthquake and bad weather. And how much due to fundamentals. 

AK:
You will have to make a judgement call 😉

Reader:
I have small position only so I think I'll hold for now , at least the dividend is good

AK:
If we are investing for income and if we got in at a lower price, this fits. 🙂


...unfavorable conditions during the year resulting in lesser operating days as
compared to previous year:
• 1H FY16/17: Earthquake in Kyushu (April 2016); Typhoon (August and September 2016);
Heavier rains (June 2016)
• 2H FY16/17: More snowfalls (February 2017)

See presentation:
http://accordiagolftrust.listedcompany.com/newsroom/20170525_183557_ADQU_RRL9A22VE4KR13RC.2.pdf

When we invest in Accordia Golf Trust, we have to be prepared for some possible fluctuation in revenue and I said this in 2015 too: 
http://singaporeanstocksinvestor.blogspot.sg/2015/11/accordia-golf-trust-dpu-of-232c-and.html

Sino Grandness and rights issue.

Reader:
Just checking can you comment on SINO GRANDNESS rights issue?
Is it worth subscribing to the rights?
Thanks

AK:
Always ask what is the reason for issuing rights. It seems like they have trouble repaying debt and, hence, the rights issue. If so, the rights issue does not add value for investors.
Subscribe if you believe that the company is able to do much better in future.

Reader:
ok thanks for the advise.

AK:
If you are putting in more money but the performance declines, it is a bad deal.

Reader:
yeah



Remember, not all rights issues are created equal. Some will enrich investors and some will impoverish them. 

In general, I do not like rights issues which happen because the balance sheet needs strengthening. They weaken our own balance sheet and do nothing to improve our cash flow.

Related post:
A lesson on rights issue from 2011.

Buying a freehold property in Singapore is still worthwhile.

Reader:
Hi AK,

        Hello! I only found out about your blog in Jan this year and have benefitted a lot from your analysis and sharing. 

        I have been reading your recent posts about upgrading to private housing. I happen to work in a landuse planning agency, hence i would like to share my views. 





While i agree that one should not upgrade to a condo if it means overstretching your finances, i think getting a freehold property might be the only way to preserve the value of your property. 

For 99 year leasehold properties, they would eventually need to be returned to the state, and the value of the flats will depreciate after it hits around its half life. 





From the capital preservation point of view, especially for couples who have kids and intend to pass down their properties to their kids, wouldn’t it still be worthwhile upgrading to a freehold property? 

The truth is that freehold land is scarce. 

        Was wondering when you bought your freehold condo, was the lease a major consideration? Would like to hear your thoughts on this 😊 Thanks!

My reply:
Hi,

Welcome to my blog. :)

You started reading my blog in January this year. So, you might have missed this:
http://singaporeanstocksinvestor.blogspot.sg/2016/12/buy-99-years-leasehold-or-freehold.html

I have friends who also work in the landuse planning agency here and when we talk about land leases in Singapore, they share our sentiments.





I won't say anything about myself but if legacy is a consideration, then, buying FH or 999 years leasehold makes more sense than a 99 years leasehold property here.

Oh, I don't mean buying a FH property in JB is better than buying a 99 years leasehold property in Singapore hor. That is not an apple with apple comparison. 

Sorry, I couldn't resist that.





Related posts:
1. Flat is 37 years old and son is 8.
2. When the lease on HDB flat ends.
(Do read the comments section too.)

When the lease on my HDB flat ends (UPDATED).

What happens to our CPF money used to buy a HDB flat when the lease ends?

Reader:
can I assume that whatever has been used to pay for the flat will be forfeited and we still need to pay back the accrued interest? 

I have friends who are paranoid over the lease issue cuz they keep on reading the anti hdb and anti CPF articles. 

End up frightening themselves.






AK:
Tell your friends it is the same anywhere in the world. 

Leasehold means there is a limited life. 

Once it is gone, it is gone. 

Money from CPF used in the purchase of such flats at the end of the lease is gone. 

Logically, if the money is gone, how to pay back?


Reader:
My friend just bought a 940k EA resale 30++y flat recently.










Simplistically, if there is 65 years left to the lease, the reader's friend is paying about $15K a year to "lease" the flat.

Of course, if we take into consideration time value of money and interest on a housing loan (or interest he could have made if he had not used his CPF money in the purchase), it would be more than $15K a year.

It is good to know that more people are thinking about this issue but don't over think. 

There is no conspiracy to impoverish anyone.





BTO HDB flats are the most affordable form of housing for Singaporeans and they come with a 99 years lease. 

Even if we were to live to be a hundred, the lease is more than enough.

The worry is when people pay top dollar for much older 99 years leasehold properties.






There is regulation in place to guard against CPF members from buying much older 99 years leasehold properties using their CPF money:

http://singaporeanstocksinvestor.blogspot.sg/2014/07/financing-purchase-of-hdb-flat-new-or.html


If a young couple decide to pay $1 million for a resale flat that has 65 years left to the lease, they have to be aware of the consequences.





We have to pay for the roof over our heads.

There is no free lunch in this world.

If we get something for free, someone else is paying for it.

If we are staying for free with our parents, it is because they paid for the roof.

People who want the CPF money which they used to buy their HDB flat returned to them after the expiry of the 99 years lease are looking for a free lunch.

Wake up.







Related posts:
1. Why I stay in a condo?
2. Resale Sengkang or BTO Bidadari?
3. Stop accrued interest from growing!

NDR 2018:
HDB, HIP, HIP II and VERS.

When will I have as much passive income as you?

What makes up a 'wealthy' face? LOL.

As my blog's readership grows, a question that gets asked more and more often is:

"When will I have as much passive income as you?"




Of course, one of the things I would say is that we have different circumstances and that financial freedom is not a race. 

All of us who reach our goals are winners. 

Some might take longer than others but they are still winners at the end.

Distilled to a word, patience.

In my retirement, I spend quite a bit of time gardening and, a few months ago, I took three cuttings from the mother Rosemary plant and planted them in a trough.


Today, I transplanted one into its own pot. 

It has been a few months but, for a Rosemary plant, its growth has been quite fast.

The other two cuttings are still nice and green but they have not grown much. 

Their time will come too. 

They are probably late bloomers. 

They are not in a rush and neither am I.




"When I find a stock that sells for 50 per cent of what I have determined it is worth, my job is basically done. Now it is up to the stock. It may move up toward its real worth today, next week, or next year... There is simply no way to know when a particular stock will appreciate, or if, in fact, it will."
(See related post no. 2)




You might want to read this blog too:
The beauty of investing in what we feel are undervalued for income is that we get paid while we wait. That makes patience more affordable.

There will always be people more successful than we are and you won't see me asking those who have more than I do:

"When will I have as much passive income as you?"




Related posts:
1. Financial freedom is not a race.
2. Little book of value investing.

Centurion Corporation Limited and pricing power.

Businesses can either be price setters or price takers. In a fiercely competitive environment where there is perfect competition, businesses are mostly price takers.

Customer:
"How much is this?"

Shop:
"$20.00"

Customer:
"Aiyoh, internet selling $10.00 only."

Shop:
"Oh... OK, $10.00."

If I were the shop owner and if this were to happen on a daily basis, I have something to worry about.

Of course, businesses could engage in anti competition moves and set prices if there are only a few players in the industry. 

So, in an oligopoly, there is always a temptation to fix prices. This, by the way, is illegal in many countries, including Singapore.

A business is in a sweet spot if they are price setters and consumers are willing to pay a higher price for what they offer.

Customer:
"How much is this?"

Shop:
"$20.00"

Customer:
"Internet selling similar for $10.00 only."

Shop:
"Then, you buy from internet lor."

Customer:
"No, I like this. OK, $20.00"

Ka-ching!

How does a business get to be in such a sweet spot?

Differentiation. 

Better quality, better features, better design etc. Something that differentiates them from the competition in a positive way which makes consumers willing to pay a premium.

This is not an easy feat. 

It is even more difficult to maintain this edge these days because copy cats are fast to act.

What? You have a patent? 

Try telling the Chinese factories.

So, if it is a product, be prepared to see copies within a matter of months, if not weeks.

What about businesses which are providing a service?

Well, they are not safe from copy cats either. Business models can be copied too.

Some are worried about the competition faced by Centurion when it comes to workers' dormitories as more players jumped on the bandwagon. 

It is a valid concern and I did say that I would keep an eye on this relatively new investment of mine. So far, so good.

Of course, I am not the only one keeping an eye on Centurion and a reader recently sent me a report by PhillipCapital dated 19 May. 

I am sharing the stuff which I find more interesting here:

1. Higher occupancy for workers’ dormitories at Westlite Woodlands (c.95% in 1Q17 vs. c.90% in 4Q16) and ASPRIWestlite Papan (89% in 1Q17 vs. 75% in 4Q16). We estimate rental rates increased c.1%.

2. 1Q17 net profit margin improved to 33% compared to 32% a year ago. The improvements 
to net profit margin was due to ASPRI-Westlite Papan becoming more profitable in 1Q17 but
slightly offset by higher Cost of Goods (“COGs”) and higher interest expense.

3. Centurion continues to enjoy a high operating leverage where they will be able to grow revenue faster than costs through positive rental reversions.

4. Singapore Workers’ Dormitory Portfolio have almost hit full occupancy by 1Q17, well ahead of our expectation of hitting full occupancy by end of 2017. We expect the supply constraints in workers’ accommodation to continue while the strong pipeline of public sector construction projects which are expected to last till 2020 will keep Centurion’s Singapore workers’ dormitories fully occupied.

5. We are pleased to see Centurion’s ability to command a price premium for its Singapore workers’ dormitories and yet ramp up its occupancy faster than expected. All these despite
competitors slashing prices and weaknesses from the oil and gas industry that we have
witnessed in 2016.

6. ... expectation for stronger operating cash flow as a result of Centurion’s continued ability to exercise pricing power in its student and worker accommodation business across markets ...

In a competitive environment, we want to invest in a business that is able to retain pricing power.

Remember this blog?

My investment portfolio.

Centurion Corporation Limited is a relatively substantial investment for me and if I were to update the list:

From $350,000 to $499,999:
AIMS AMP Cap Ind'l REIT

From $200,000 to $349,999:
ACCORDIA Golf Trust
CROESUS Retail Trust
FIRST REIT

From $100,000 to $199,999:
ASCENDAS H-Trust
QAF Limited
WILMAR Int'l
Centurion Corporation Limited

What made me invest in Centurion Corporation Limited again? The answer is in this blog:

Added Centurion Corporation Limited to my investment portfolio.

Related posts:
1. Full year 2016 report.

2. Centurion to double in price?

Prudent retirement funding strategy for elderly parents.

Reader:
Hi AK, apologies for the multiple questions from me. 🙂 I am looking to help my parents with their retirement planning and hope you could shed some light.

For convenience of calculation and discussion, assuming the following hypothetical figures, can you share how you would do the planning?

Parent A - 500k cash
parent b - 300k cash,
Zero CPF for both,
No existing loans at all
Children all financially independent
Require about 2k per mth for expenses
Occasional traveling

Given the above I was thinking of topping up their retirement account to the ERS and opt into cpf life at 65.

The remainder will be kept in minimum risk instruments like FDs etc and maybe just a small percentage into shares. Hope you can help me out in your free time. Thanks a lot!

Both parents have basic health insurance. I am thinking of getting them to surrender their whole life policy bought donkey years ago with low sums assured as we children are all financially independent.



AK:
What you are planning to do sounds like what I would do if I were in your shoes. Spooky!
Old folks should not be too adventurous with their money.

Reader:
I read your blog daily! I guess that's where I get all my thoughts mainly. Can't thank you enough!

Related posts:
1. Elderly with spare cash.
2. How to make money last longer?
3. FRS, BRS and ERS.
4. Parents have enough H&S cover?
5. Dad terminated his whole life policy.