Investing With The News

Foreword from ShareInvestor

This article “Investing With The News” by Cai HaoXiang was first published in The Business Times on 13 Jul 2015 and is reproduced in this blog in its entirety.

You can buy on the news, but you have to think in a contrarian way

The importance of news is often derided by value investors.

Ignore the noise, they say. Stick to what you believe in. The media only likes to stoke up greed and fear. Ignore the news.

In my limited experience dabbling in stock markets, there have been real opportunities to buy on news. These opportunities only come once or twice a year.

When they come – when something, definitely, has hit the fan – it is time to act.

The past week has been such an occasion. One can combine an assessment of the news with the hard facts on the ground.

Usually, markets have a really bad day when they are collectively down 2 per cent, at most 3 per cent.

The entire Hong Kong market, which is not expensively valued to begin with, fell a whopping 8 per cent at one time on Wednesday afternoon.

Panic from the ongoing share price correction in China, which had been building up for some time from what one can gather from news reports, had finally overwhelmed common sense. Markets had finally fallen to a point where even policymakers appeared to have panicked.

It was a fantastic opportunity to get in. Those with a short-time horizon made substantial profits betting on the likely rebound that usually follows such a dramatic drop.

Another example I remember was at the beginning of 2013, when article after article talked about tech firm Apple’s demise after the death of its visionary founder Steve Jobs.

Apple happened to be facing a slow patch of sales. It was silent about new products. Its attempts at mapping were laughable. Share prices kept falling, from a peak of US$700 to around US$400, even though the company remained enormously profitable and kept on accumulating cash.

Valuation levels, excluding cash, were at five or six times earnings. One would have to expect Apple iPhone sales to halve over the next year and stay that way forever before pricing it thus. And that was opportunity – the stock doubled over the next two years after people realised the company still had the ability to keep making phones people wanted.

The affinity to buy during panics is an acquired taste. You have to be contrarian. Even harder is honing the knack of realising when people are too complacent.

Reading the news, a reflection of the current mood of the market, can provide such a gauge of sentiment.

The market adage is: Do not to catch a falling knife. That is, don’t buy when stocks are falling steeply, because they can fall even more.

I disagree. Given a long-enough time horizon and sufficient cash, you can catch a falling knife and survive.

However, you cannot catch the knife at the beginning of its fall, when stocks are significantly overvalued. How to judge this is a matter of experience.

It is impossible to time the bottom of the market. Better to deploy bit by bit when markets have fallen significantly, and average down, rather than miss the opportunity to act.

To ensure you do not get cut too deeply, you have to wait until the newsflow is bad enough.

This is an art.

You have to sense that something has hit the fan.

Value Matters, But Respect Momentum

I ran into an acquaintance recently. He was from China, so we began talking about the Chinese stock market.

He told me he had put some money on a stock on the Shenzhen Stock Exchange a few months ago.

I was aghast, given the incredible valuations stocks there were trading at, which were easily 80 to 100 times their earnings.

Why did you buy? I asked him.

He said it was on a friend’s tip.

Like many Chinese retail investors, he went with the herd and has no idea of the significance of the simplest of financial indicators, the price- to-earnings (PE) ratio.

Buying on value means, for a start, comparing a stock’s PE ratio against its historical averages, and against the averages its peers are trading at.

If you find a stock that is undervalued relative to history and its peers, you have a potential buy.

But don’t go and buy it immediately. You have to figure out why the market thinks it is not a good buy, and whether the market is wrong.

You also consider other things like financial strength and industry fundamentals.

While it is fine to say you are a value investor, adhering to its principles can be a challenge. For example, it is not easy to assess whether a company has a competitive advantage versus its peers, or whether that situation will change anytime soon.

Value investors should also not forget that money can be made by respecting momentum. Momentum refers to how investors keep piling onto a trend until valuations become too high. Volumes traded keep increasing.

Self-professed value investors shouldn’t scorn the “buy when everyone is buying, sell when everyone is selling” rule of momentum investing.

For the past half-year, the China A-share market has been a momentum market, dictated by government policy.

Value investing has little place there.

In China, it does not matter what you think. What matters is what the market thinks. And sometimes, you cannot fight the herd.

Nevertheless, it is in the market for H-shares – China stocks listed in Hong Kong – that value investors looking for China exposure can find a playground.

These are companies listed in Hong Kong which the Chinese government has a vested interest in ensuring they stay stable. (What China’s long-term plans for Hong Kong are, the Hong Kong dollar, and H-shares, are another issue altogether.)

The Comfort Of Low-Volatility Stocks

By accident more than design, my current portfolio contains a number of low volatility stocks that don’t move much no matter what happens to the market, but still yield something beyond the paltry interest rates offered by banks. This has given me some peace of mind amid market turmoil. For example, I have some H-shares in a large bank outside China’s Big Four which, during the last few turbulent weeks, tended not to fall as much as the market. I noticed any sharp fall results in a sharp bounceback due to buying interest.

Try to find stocks like these by comparing their movements against the movements of an index.

Sometimes, these are companies which have achieved a dominant position in some way.

When everyone is selling, more people believe in these companies than not. These stocks will still fall in price, but they can bounce back quickly should a recovery take hold.

In Singapore, there is a lack of liquidity and interest in the market, so stocks are generally not that volatile.

Low-volatility stocks range from small to large companies.

There are many small caps here, too many to name, that don’t move for years but still pay out decent dividends.

As for large caps, one such example is Haw Par Corp, the Wee family’s investment vehicle in UOB and other smaller companies. Most of its value is taken up by UOB.

For the entirety of 2014, Haw Par stayed pretty much at one price – S$8.50. UOB, by contrast, went through far wilder swings. UOB however offered a better return.

Another large cap, palm oil processor Wilmar International, has effectively fallen out of the radar of institutional investors. It has been trading roughly between S$3 and S$3.50 for three years straight.

Wilmar is a play on rising consumption of basic necessities in Asia. It has been affected by fears of slowing China growth and the commodity price crash. It is still investing.

I have been holding on to both and am perfectly happy to add to them once in a while.

Their low volatility can be illusory, of course. In a global financial crisis or if there is some company-specific problem, prices will plunge.

For now, valuations provide some buffer. Haw Par typically trades at around a 30 per cent discount to its book value. I bought it when the discount was a bit wider. Wilmar, meanwhile, is trading at roughly its book value.

As long as both companies remain profitable, their book values will gradually increase over time, and their stock prices will follow. The downsides will hopefully be limited.

Both have a dividend yield of slightly above 2 per cent. I’m not complaining: This is still far better than what any bank, UOB included, can pay me for my cash.

For now, there is little buzz around both stocks. Let’s hope it stays that way.

Because as the proverb goes, no news is good news.