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Concentrate or diversify?

Wednesday, May 7, 2014

Sharing an email exchange here:

Hi AK,

 
I am a retail investor who has been investing for some time, and I've also been a long time reader of your blog. Before I go on any further, I would like to thank you for your blog as it has provided many people with valuable insights on investing and personal finance. Your contribution to the investment community is immense, I sincerely hope that you continue blogging!
 
I have a question regarding diversification vs concentration. While I am aware of the benefits of both strategy, I'd like to hear your view on this topic. Very often, I find myself identifying several undervalued companies. However, instead of buying all of them, I try to narrow it down to 1 or 2 high conviction stocks. As such, my portfolio tends to be extremely concentrated. I take into account factors such as the potential upside, catalyst, expected holding period, circle of competence etc.

While my investment record is satisfactory, I have missed many opportunities (mainly because it is impossible to predict when prices will rise) when I did not buy the other undervalued stocks.

Diversification will solve that problem. However, I might risk missing out on huge gains from my high conviction ideas just because I don't want to lose out on the others when prices rise. I hope to find an investment philosophy that would help me reconcile these two strategies and would love to hear your views on this. Thank you.

Regards,
WJ
 
 
My reply:

Hi WJ,

From your email, I get the impression that you prefer a concentration strategy. You have, however, rightly pointed out one of the weaknesses of such a strategy, especially if our funds are limited.

There is a simple solution to the problem you have. Do a lesser form of concentration. What is this?

Let us say you had identified 10 stocks which met your criteria, instead of selecting 2 stocks to put all your money into, put 50% of your money into these 2 stocks. The other 8 stocks get the rest of your money.

You could argue that this is diversification but diversification to me is 10% of your money in each of the 10 stocks. OK, if you like, my suggestion is an adulterated form of diversification. A rose by any other name smells just as sweet. ;p

Best wishes,
AK

Related posts:
1. Excuse me? Are you an investor?
2.  Luck plays a part in investing.
3. The Little Book That Beats The Market.
4. Approach to stock selection.
5. Value investing.


Marco Polo Marine: Reason for price weakness.

Tuesday, May 6, 2014

Yesterday, a couple of readers asked me what could be wrong with Marco Polo Marine since the share price declined. A reader also asked me where the next support could be, using technical analysis. Last night, I checked if there were any announcements from the company and found a plausible reason for the recent weakness in share price.

We know that Marco Polo Marine has an Indonesian subsidiary, PT Pelayaran National Bina Buana Raya (BBR). Well, the subsidiary has released 1Q 2014 results and the numbers are very bad. Of course, BBR is not all of Marco Polo Marine's business but it is a significant part. So, I would expect Marco Polo Marine's own quarterly results to be affected. How badly affected would depend on how other business segments perform, of course.


Now, the BBR story:

Over at BBR, revenue reduced by 11% while direct expenses increased almost 20%.

The OSV segment of the business did well as revenue improved some 57.3%. However, Tug and Barge vessels segment of the business saw a reduction in revenue by some 47.5%. (The two segments put together, OSV segment now has a 61.5% share of total revenue.)

OSVs are clearly profitable while Tug and Barge vessels are not. Why? OSVs recorded $4.8 million in revenue and incurred expenses of $2.1 million. However, Tug and Barge vessels recorded $3.18 million in revenue but incurred expenses of $4.37 million! This segment bled massively!

In the same quarter in the preceding year, the Tug and Barge vessels segment of the business turned in a revenue of $5.84 million and incurred expenses of $3.95 million. This suggests to me that the expenses incurred by this segment has been quite consistent but the revenue drop, year on year, is astounding!

If this were to continue, BBR would be better off without the Tug and Barge vessels segment of the business. Gross profit declined a massive 62.5%. Operating income declined by 73.5%. After financial charges and income tax, total comprehensive income reduced by 92.1% for the quarter, year on year!


How does this affect my investment thesis?

With the decision to gear up significantly to purchase a jack up rig which could potentially double earnings in FY2016, I was prepared to accept lower earnings in the next two years because of the much higher finance costs resulting from the MTNs although I have to admit that the jack up rig was never a part of my initial investment thesis for Marco Polo Marine.

With the jack up rig and higher finance cost thrown in for the next couple of years, I rationalised that as long as operating income improves steadily over time with more OSVs being added in the same period of time, logically, any decline in earnings due to the higher finance costs could be cushioned. This was an important assumption.

I said that to stay invested in Marco Polo Marine is to believe that:

1. Earnings will improve as more OSVs join the fleet in the next 2 years.

2. The rig delivery by end of 2015 will improve earnings massively.

If well executed, the strategy will catapult earnings upwards, possibly doubling EPS by 2016.

Now, for earnings to improve gradually over time until the jack up rig is delivered by end of 2015, I had focused on the OSV segment of the business as the growth driver. I had simply assumed that the Tug and Barge vessels segment of the business would continue plodding on and that the segment's revenue and expenses would more or less stay constant.

So, for BBR's Tug and Barge vessels segment to turn in a massive loss is a shocker and this has thrown a spanner into my thesis for having a significant investment in Marco Polo Marine.

Does it mean I no longer believe that Marco Polo Marine is on the right track? No. In fact, if not for the decision to focus on growing its fleet of OSVs, BBR would have turned in a loss making quarter instead of one with much lower earnings.
 
Unfortunately, to be realistic, FY 2014's numbers could turn out to be disappointing, everything else remaining equal. This is even if the Tug and Barge vessels segment of BBR's business should see revenue improving and expenses reducing in the next two quarters to what should be the mean.

Lower utilisation of the Tug and Barge vessels in the preceding quarter was put down to seasonal factors (i.e. monsoon period). Expectations of a reversion to the mean did not happen. Is this weakness in the segment temporary or is it going to be more enduring? I am inclined to believe that it is temporary but if a reversion to the mean does not happen in the following quarter, then, the risk of being invested in Marco Polo Marine could be much higher than initially thought.

I am staying invested as I still believe in the growth story but I should move Marco Polo Marine higher up in the pyramid (see related post no. 1 below) from an investment that is for growth and some income to just being an investment for growth. Without the income component, my approach will demand that I trim the size of my investment in the business.

See BBR's 1Q 2014 results: here.

Related posts:
1. Motivations and methods in investing.
2. Marco Polo Marine: Drilling for higher income.

LMIR: 1Q 2014 DPU 0.68c.

Monday, May 5, 2014

There isn't much to say about LMIR's results but this is a quick blog post in response to a guest blogger's request. (Hey, you know who you are and I am still waiting for your next guest blog, ok? LOL.)

In my last blog post on LMIR, I said that:

"... we are likely to see DPU in S$ terms recovering in the next quarter as financial expenses normalise and I have estimated that a DPU of 0.66c is realistic."


Well, LMIR has done a bit better and declared a DPU of 0.68c for the quarter. Making the assumption that all things remain equal, at 41c a unit, we are looking at a distribution yield of 6.63%.

Now, I would ask the question that with the issues which investors in LMIR have to accept, is 6.63% attractive enough?

Issues? What issues?

I am going to be lazy. If you cannot remember, you might want to read this blog post again:
LMIR: Gearing ratio and margin of safety.

As an investment for income, I feel that LMIR can only become attractive again if the Rupiah appreciates meaningfully. When is that going to happen? Your guess is as good as mine.

In the meantime, if I were to put more of my money in LMIR, I will have to demand a much higher distribution yield than 6.63%.

See 1Q 2014 presentation slides: here.

If my car is a luxury... (Buying a $500,000 watch after 3 years of work.)

AK is catching up with the times. 

These days, I get plenty of news and perspectives from what I read on Facebook. 

Of course, there will be things we agree with and things which we don't. 





However, as Rumpole of the Bailey would say, 

"I might not agree with what you say but I will defend to the end your right to say it.

Well, something to that effect. 

My memory is a bit patchy.






Recently, I read on Facebook about a young person who aims to be the owner of a $500,000 watch 3 years from now. 

The person who posted this on Facebook believes that this young man will be able to achieve it and will prove a crowd of disbelievers wrong. 

I certainly agree that it is important to believe in ourselves, believe that we can make our dreams a reality.





Price tag: $500K.





I admire the fighting spirit that this young man has and he reminds me of someone very dear to me. 

He worked hard to make lots of money and bought luxury watches, cars, shoes etc. 

A picture of success but, till today, he still has to work hard for a living. 

The day he stops working, his income stream will dry up.





I quite understand that every person is different but I hope that this young person will meet someone who will impress upon him why he should not buy that $500,000 watch once he is able to afford it. 

Of course, that said, it is his life and the choice is clearly his.





Not many people, fresh out of school, are able to save $500,000 in 3 years. 

I would assume that for someone to be able to save $500,000 in 3 years, he would have an earned income which is much more than that. 

That is some pretty amazing earning power.





However, it would be a mistake to spend all that money on a watch if that was all the money he had put aside after three years of work. 

It would be a bigger mistake to think that nothing could ever put a stop to this amazing earning power.





"Live within your income and save so that you can invest. Learn what you need to learn... Like Warren, I had a considerable passion to get rich, not because I wanted Ferraris – I wanted the independence." 
Charlie Munger.


Related posts:
1. To be a happy peasant.
2. If we are not rich, don't act rich.
3. From rich to broke?

Asia Invest Symposium by ShareInvestor.

Sunday, May 4, 2014

Are you free on the 31st of May (Saturday) from 9am to 1.30pm? If you are, you might want to go listen to Mr. Roger Montgomery, a famous value investor, who will speak for 2 hours at an event organised by ShareInvestor.

He will share his knowledge and experience and cover topics like the following:

- Strategies to Spot High Quality Businesses to Improve your Returns on Stocks.

- How to Buy the Best Stocks for Less Than they're worth?


I know for a fact that it is not cheap to bring in big names like him. So, when I was approached to help spread the word about the event, I was surprised that tickets are priced at only $9.90 for one and $14.80 for a pair.

For those who also do some trading, you will also be interested to know that there is another speaker at the event, Mr. Stuart McPhee.

He will cover topics like the following:

- Trading Strategies in the Stock Indices & Commodities Market.

- How To Identify High Probability Patterns when Trading Forex?

With tickets priced at $9.90 each, I was somewhat worried but I have been assured by the organiser that "there will be no selling or backend products throughout the event."

However, Oanda will be promoting their platform during the event and if you should open an account with them, you will get a book by either Stuart or Roger for free!

I love getting value for money and, in my opinion, this is a value for money event! If you would like to find out more or buy tickets, follow this link: Asia Invest Symposium.


Wishing everyone a happy Sunday!

CapitaMalls Asia: Farewell.

Saturday, May 3, 2014

I have filled the form in acceptance of the voluntary conditional cash offer for CapitaMalls Asia.

Although there are arguments that the offer price is unfair and although I can understand the arguments, I feel that there is a great degree of subjectivity too. Much is relative.

Just like how we compare an investment with another to see how it could be undervalued or overvalued, we could also compare an investment with itself in the past to see how its value has changed over time.


CapitaLand’s offer works out to about 1.2x CapitaMalls Asia’s book value now which is cheaper than the 1.5x book value when it listed in 2009. If we want 1.5x book value today, the price is closer to $2.70 a share.

So, for someone who bought into CapitaMalls Asia at the IPO price of $2.12 a share, obviously, the voluntary conditional cash offer of $2.22 a share leaves a bad taste in the mouth. However, for someone who bought at under $1.20 a share during the lows in late 2011 which was at a 20% discount to the NAV/share back then, $2.22 is probably a sweet enough exit price.

I think it is a fair enough offer and I explained why in an earlier blog post:

"The NAV/share is $1.84. So, this offer is a 20% premium to book value. NAV grew 10% year on year. So, being paid $2.22 a share, it is like getting paid in advance for growth that is likely to happen in the next couple of years."

We might want to remember what Warren Buffett thinks of IPOs. If you cannot remember, go to the earlier blog post I mentioned above: CapitaMalls Asia: Being offered $2.22 a share.

Better to wait for a price that is so attractive that even a mediocre sale gives good results.

The Amazing Spider-Man 2!

Friday, May 2, 2014

My broker has done it again!





Also, I got a free dinner, a free tub of pop corn and a bottle of Pepsi! Happy!




Two thumbs up!

Related post:
A movie treat from my stock broker.

First REIT: Reply from the management.

Thursday, May 1, 2014

A reader, Gregg, first shared his concerns regarding Sarang Hospital in First REIT's portfolio here in the comments section: Gregg's comment.

Sarang Hospital

Another reader wrote in with a list of questions for the REIT's management and shared these with me in an email. Here is the email with the replies from the management in red.

1. Noted that there is impairment provided in subsidiary of S$8,136,000 in the statement of total return. Could you advise me the reason of this impairment being provided and which subsidiary? Understand usually DCF was prepared to determine whether impairment is necessary. Since the impairment is being provided, does that means that the present value of the future cash flow is lower than the carrying amount of the investment?
 
We have made some provisions for impairment to our investment in South Korea, Sarang Hospital.
This S$8.1m is the impairment provided at Trust level for Kalmore Investments Pte Ltd, the holding company of Kalmore (Korea) Limited which owned Sarang Hospital. 
 
2. Under note 9 of the financial statements, there is deferred tax income recognised relating to changes in fair value of investment properties of S$11,667,000 despite the fact that there is increase in fair value of investment properties of S$61,334,000 (net) under note 12. Could you advise which property does the S$11m relating to? 
 
The write back of the deferred tax relates to the Indonesia properties mainly due to lower building reinstatement values as provided by the independent valuers, as compared to the net book value of the properties.
 
3. In note 14 of the financial statements, an impairment allowance is provided of S$2.165 million. Please advise which property it is related to and what are the Trust's action to recover this debt. Noted that there was also provision made in prior year of S$547k, is it relating to the same debtor? 
 
The impairment allowance of S$2.165 million was made for Sarang Hospital.  We have taken legal actions in the past two years to recover the debt from the vendor.
 
There is no provision of S$547K make in the prior year however the provision of S$567K was made for amount due (intercompany balance) from Kalmore Investment Pte Ltd (Subsidiary of First REIT) at Trust Level in FY2013.
 
4. Noted that the fair value of Sarang Hospital decreased to S$6.3m compared to purchase price of S$13m. Please advise the reason of 50% decrease in fair value. 
 
·         As the Vendor and Guarantor for the Master Lease Agreement encountered unforeseen financial difficulties, he was unable to fulfill his contracted rental obligation.
 
·         Hence, through the Valuer’s (CBRE) independent assessment and judgement, it was more appropriate to value Sarang Hospital on a “market rental basis”, ignoring the contracted rental in the Master Lease Agreement which was guaranteed by the Vendor.
 
·         Due to the lack of similar comparables in the market, the Valuer has adopted a “proxy approach” to determine the market rent. Apart from the Valuer’s investigations into rentals achieved with comparable properties and within the broader market, the Valuer has relied on anecdotal evidence which include their discussions with active brokers, investment and fund managers as well as fund investors.
 
·         They have also considered the relativity of asset class pricing. This includes the relativity of the healthcare real estate sector against other comparable markets, and the relativity of the healthcare real estate sector against other asset classes within the relevant market.
 

I suppose that the curious decision of buying a lone property in South Korea has turned out to be a bad one. Fortunately, it should not have a big negative impact on the REIT as a whole.

Related post:
First REIT: Purchase in South Korea.
(Dated 9 July 2011.)


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