Portfolio Size
1. Warren Buffett is a “Focused Investor” investing only in companies which he considers outstanding. His portfolio consists of much fewer stocks compared to fund managers who manage a similar portfolio size.
2. Peter Lynch had to manage a huge portfolio of stocks – more than 1000 shares. In page 239 of his book, he says that it’s best to own as many stocks as there are situations in which (a) you’ve got an edge; and (b) you’ve uncovered an exciting prospect that passes all the tests of research.

Buy Criteria
1. Warren Buffett makes investment decisions primarily using valuation – he buys good businesses/shares where the market value is less than the “intrinsic value”, a figure he appraises using his discounted cash flow model.
2. Peter Lynch buys shares using a number of different approaches, looking at PE ratio, cash position, relative valuation against market, looking at whether you have an “edge” in the industry etc. He even categorizes companies into 6 types and determines how you should approach each type of investment.

Holding Period
1. Warren Buffett says: “our favourite holding period is forever”.
2. Peter Lynch buys and sells his shares. I do not believe he has any hard and fast rules as to minimum or maximum holding period.

Market Fluctuations
1. Warren Buffett is not concerned about market fluctuations at all.
2. It doesn’t say anywhere but I guess Peter Lynch, being a Portfolio Manager needs to consider things like performance benchmarking and negative investment returns.

Risk
1. Warren Buffet’s concept of risk is that the lower the share price, the lower the risk.
2. Interesting Peter Lynch does not address the issue of risk much in his book.

The Economy
1. Warren Buffett ignores the economy when making investment decisions.
2. Peter Lynch takes the view that it is more or less impossible to predict the economy, but he does say that “practical economists are economists after my own heart”, for example “those like Ed Hyman at CJ Lawrence who looks at scrap prices, inventories, railroad car deliveries.” I believe Lynch considers some indicators to be important too.

Comfort Zone
1. Warren Buffet stays away from tech stocks generally, things that he does not understand.
2. Peter Lynch seems to be more open saying that he discovered some of his best stocks through eating and shopping. In fact in Page 11 of his book, he describes how he missed out on the Amazon.com opportunity even though the company was easy enough to understand. He admitted that he was not flexible enough to see the opportunity in its new guise.

As you can see both Buffett and Lynch are very different investors, yet both have outstanding track record. I believe the lesson here is that you can still develop your own investment style which works for you.

Our market in Bursa Malaysia is very different from Wall Street. For example, utility companies which may be deemed safe in western countries are sometimes subject to political whims and fancies in Malaysia. Yet many of the IPPs and other utilities have huge borrowings. I guess time will tell whether such utilities can be considered a “safe investment”.

Notably she made lots of money by investing and holding on to a pharmaceutical stock called Schering Plough. From what I read, she has never sold a share… just kept holding on and buying more.

What? Buy and Hold? “That’s just not for today’s market!” … I hear you say.

Maybe so.

Last night while watching CNBC, I heard a commentator say that US stocks are trading lower now than they were 10 years ago. That includes many of the big blue chips.

I haven’t held stocks for that long, but the ones I’ve held for 3-4 years are mostly out of the money… which means I’m sitting on paper losses. So in hindsight, should I have sold 6 or 12 months ago?  Sure… but you know what they say about hindsight right?

I’ve always held the view that short of the divine, it is impossible to time the market.

Meaning that you never know when the market has peaked and when it has hit rock bottom. So why try to time the market at all? Just decide that you want to be an investor for your Life Occupation and don’t even think about quitting your job!

“When times are good, be happy; but when times are bad, consider: God has made the one as well as the other.”
Ecclesiastes 7:14 (NIV)

But having said that, I’d agree that for most people, Buy and Sell is better than Buy and Hold.

In his book Even Buffett Isn’t Perfect, author Vahan Janjigian suggests that “unless you have access to Buffett-like resources, it is better to think of yourself as a stock buyer than a business buyer.”

See unlike Buffett, I can’t afford to buy the entire company and totally ignore the share price. In contrast, if Buffett feels that Mr Market is being foolish, well he can just buy the whole company right?

There’s a big difference when you can afford to buy the whole thing. Think about it… if you bought a house and someone comes along tomorrow and tells you it’s worth 30% less, would you listen to him? You’d probably tell him to fly a kite wouldn’t you? You’ve bought the house, you can afford to pay the bank loan, you can afford to keep it for the next 10 years and you know it will go up eventually. So why listen to Mr Market?

But hang on, what about Anne Scheiber? She doesn’t have Buffett-like resources – yet Buy and Hold has worked for her!

Buy and Hold is Fantastic

… if you can pick wonderful companies and have an investment horizon of 40 years.

Both Warren Buffett and Anne Scheiber have been investors for more than 40 years.

Anne Scheiber invested in businesses that she knew and understood. She loved the movies. And she invested in Columbia, Paramount and so on. She was a Coke/Pepsi drinker and she had shares in both. She took medication, so she invested in Schering Plough and Bristol Myers Squibb.

Actually if you believe Peter Lynch, picking the right stocks is not beyond the normal person:

“Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks as well as, if not better, than the average Wall Street expert.”

Oriental Holdings Berhad – What if You had Bought and Held?

I happened to be reading the Annual Report of Oriental Holdings Berhad (ORIENT) the other day and came across a statement by Chairman Dato Loh Cheng Yean:

“A holding of 1,000 stocks in Oriental when it was listed in 1964 would translate into 40,255 Oriental stocks worth RM263,670, based on the share price of RM6.55 at the end of 2007. In addition the stocks would have earned a total gross dividend of RM137,660. The gross dividends received and the appreciation in value is equivalent to a remarkable average rate of return of 14.60% for each of the 44 years.”

This sounds pretty good… see once again we’re talking 40 years. I find Oriental Holdings to be quite “remarkable” because it is such a diverse collection of different businesses which include auto assembly, auto parts manufacturing, oil palm, hotels, property etc. But 85% of its RM498 million Operating Profit is from auto and oil palm.

Oriental Holdings Bhd (ORIENT)

In the 4-5 years after the 1997 crash, Oriental’s earnings were down or at best flat, then since 2001 it started taking off and the company became a cash cow, building its Net Cash position to more than RM1.3 billion as at end-2007.

Oriental Holdings is a low profile company. I remember that I mentioned this company to a friend casually over dinner one night and she’s never heard of it. And this was no ordinary friend – she’s a Fund Manager & Analyst.

But if you had bought and held on to this company since listing, you’d be pretty happy.

“He who gets wisdom loves his own soul. He who cherishes understanding prospers.”
Proverbs 19:8

Knowledge itself is not power. It is the understanding that knowledge brings or the application of knowledge where power lies.

Likewise if we train ourselves to know and understand our stock investments, we can become wiser investors and get better results.

Here are a few things I’ve learned which work well for me. I’m sure it’s NOT the only way to make money but I hope it gives you that extra knowledge and wisdom that you can apply to your own investments.

BUY GOOD COMPANIES

This is like stating the obvious but believe it or not, this is not the starting point for many people! For many the rule is to buy stocks which will go up. And what will go up is what I heard while playing mahjong… Hmm I hope you don’t “play share” like this

What are good companies?

Good companies are those that consistently generate an increasing stream of cash for shareholders. Over time, the dividends keep increasing and over time your share price will go up also.

So how do you find good companies? If you have a trusted advisor then great – you’d save yourself a lot of work and effort! But personally I do it the hard way. My starting criteria:

1. Big Companies
I am kiasu (and kiasi) so I usually prefer big companies, usually with market cap of more than RM1 billion. Most large companies have many years track record which I feel provides more comfort. And you are also in the same boat with institutions and other influential shareholders. This will keep management in check.

But big in itself is not a guarantee against failure. Just look at what happened to AIG and General Motors. And even Citigroup… the bank that ruled the world 10 years ago. We need to monitor our investments from time to time and look for any signs of crack in the company. Whether management has overextended the company, or in the case of General Motors, “who moved my cheese”?

In fact just like a huge ship, the bigger you are the less agile you become.

What about Fast Growing Small Stocks?
Yep this is where you make the most money according to Peter Lynch. I do have one or two small stocks but I won’t be adding more for now. When the market recovers, it will be led by the large caps first. If I make some money on my large caps, then I start turning a few rocks on the small caps.

2. Market Share
The companies I like are usually market leaders or have huge market share in their business. Usually you can see their product or outlet in major malls/neighbourhoods.

I’m not too concerned what business they’re in unless it’s a dying business. If you’re selling fridges to Eskimos while everyone else is selling blankets, then you’ve got a problem. The main thing is that they are good in what they do. Warren Buffet says that the company should have a moat (barrier against competitors) but it’s quite hard to know this sometimes.

Why bother about market share?
Simply because market share means everyday customers. Most probably you have a business where people need to buy your stuff everyday. And if you do your business well, you will have a cash cow. Most likely you will end up with a huge market share if the barriers to entry are high.

Beware the government monopolies. These companies have huge market share but they got there largely by government backing and protection… and we all know how spoiled kids behave. Don’t ask me to mention names, you know who they are! Having said that I do admire companies in the Petronas group for their professional management and good governance.

3. Earnings & Dividends
Look at the 5 year profit track record. Or even better 10 years if they have. If Profit and Free Cash Flow have grown significantly during this period then it’s a good starting point. You will need to be slightly financial literate if you are taking the DIY approach like me. I will explain some of this financial stuff next time.

Beware of Fake Profits
What do I mean by this? It is easy for management to fudge the profit figure, eg boosting inventory value, or fake sales which go into receivables but never end up collected – sounds familiar? We will need to look at a thing called Free Cash Flow which I will explain next time.

“The word most frequently seen with earnings is surpise”
Peter Lynch

Trying to predict future earnings can be tough. I sympathise with those analysts who publish 3 year earnings forecasts. I would much rather look at how a company plans to increase its earnings and check periodically to see if the plans are working out.

4. Balance Sheet
Gearing must not be excessive – the company’s Net Debt (borrowings minus cash) should not exceed 40% of its Shareholders Funds.

Also good companies use their capital efficiently. They should be getting at least 12% return on equity. By the way, Malaysian Banks are currently quite good in this area. But they are being hammered in the market now because of the fear factor. Here’s a trustworthy saying:

“Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to missappraised.”
Warren Buffett

Stay tuned. In Part 2… the People Factor, Cheap Companies and Stock Market Timing.
To be continued…

Doesn’t sound too impressive to you? Well think twice…

21.1% per annum compound means that if you had invested just one dollar in 1964, your buck would have grown to $4553 by 2007! Page 3 of the Annual Report says:

“Over the last 43 years (that is, since present management took over) book value has grown from $19 to $78,008″

(By the way, the 21.1% is after tax!)

So now you can see why Warren Buffett is easily the Richest Man in the World.

Still think it is realistic to target 30% return per month on Bursa Malaysia?

In fact I say that it is nearly impossible for anyone to repeat what Buffett has achieved. One thing to note is that Berkshire has achieved its growth not just from stock market investments but in buying controlling stakes in many businesses. This makes him different from other money managers… and also different from other business owners. His unique approach makes him both an outstanding fund manager and business owner at the same time.

Look at Berkshire’s Balance Sheet as at 31 December 2007 and you will see that Equity Securities amount to US$75 billion or just 27% of Berkshire’s total assets of US$273.2 billion.

The rest of the assets comprise fixed income investments and the businesses which Buffett has acquired over the years. These are businesses in industries which include utilities, energy, retailing, manufacturing and services.

This means that the value of much of Berkshire’s assets is not subject to stock market vagaries. As long as his businesses are performing, Berkshire will do well no matter what the stockmarket does.

Click to enlarge
Source: Berkshire Hathaway Inc - 2007 Annual Report

On 16 October 2008, the New York Times published an op-ed letter contributed by Warren Buffett. The message of the letter was clear–Buffett is a buyer of US stocks.

In the letter, Buffett offers a few words of wisdom which has made him perhaps the greatest investor of all time.

“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.”

Buffett says that people who are high in cash have opted for a “terrible long-term asset”. Personally Buffett is planning to move towards 100% in US Equities.

“If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.”

Buffett draws some analogies between previous recessions/depressions and how the stockmarket usually runs ahead of the economy. When we look at the carnage even in Malaysia, it does make sense. Fundamentals have not changed much except that we are looking at a global slowdown which will affect us somewhat. However liquidity is ample, exports are stable, ringgit is low and interest rates are low.

“In short, bad news is an investor’s friend.”

So what Buffett said can be equally applied to Malaysia!

You can read more about the article here:
http://www.nytimes.com/2008/10/17/opinion/17buffett.html

The current market climate is certainly not for the faint-hearted. It is during times like this that we would do well to remember the words of Warren Buffett:

“As far as I am concerned, the stock market doesn’t exist. It is there only as a reference to see if anybody is offering to do something foolish.”