There is No Certainty in the Markets Today Except Certainty of Uncertainty

Dear Friends,

When you hear of news that Las Vegas Sands the world's largest casino group, owned by Mr. Sheldon Adelson, the 3rd Richest Man in the US for the year 2007, is facing potential bankruptcy, you know the economic situation is extremely abnormal.



This news is especially important to Singaporeans who thought that the Marina Bay Integrated Resort Project (Casino) was a "sure thing". More important is today's news report from Channel News Asia that the Singapore Government will not bail out Marina Bay IR Project

DO NOT SIMPLY BELIEVE THAT A BUY & HOLD STRATEGY IS A WINNING STRATEGY TODAY

This situation is a lesson that "Buy & Hold" Strategy will not necessarily work this time. It did not work for Japan, and no one knows for sure that it will work for US.

It is important to note that the US Financial & Economic System is experiencing similar economic situation as that experienced by Japan in 1990, although it is claimed that the US Government is acting differently from the Japanese Government, and thus, the US Stock Market will not perform in a similar manner as the Japanese Stock Market.

Why shouldn't the US Stock Market be lethargic from now on, like the Japanese Stock Market for the last two decades?

Just because the US Government is acting differently? Is it really acting differently? How is the US Government acting?

Just today, Treasury Secretary Hank Paulson has announced that the Government will not be buying toxic assets in the article Stocks Beaten Down by Changes in Bailout Plan.

Can we even be sure of what the US Government will really be doing in the next 6 months? Will there be flip flops in their decisions? I think there has to be, because I don't think the US Government can really bail out every financial institution in the US, not to mention other industries.

Also, more importantly, how can we simply shrug off the similarities of the Japanese 1990 economic situation and the current US situation? To assume that any Government, even the US Government has control over the economic situation is way to presumptious.

If any Government has control over its economy, it should be the Singapore Government with its vast financial and management resources. Yet, Singapore continues to experience economic recessions after economic recessions. Even more importantly, Singapore is unable to avert the current economic recession, despite the money and management resources available, and despite the fact that it is not affected in any significant manner by the Banking Crisis.

If Singapore can't be sure of a short recession, what makes anyone think that the US Recession will be short? Sigh ..... there's a lot of wishful thinking with highly biased opinions by a lot of supposedly highly intelligent, experienced fund managers and analysts today.

Be very careful. A fool and his money are soon parted.

Fundamental Analysis works only if one can forecast with a high degree of accuracy and reliability the financial results and the valuation of the Balance Sheet Assets of the relevant stock.

Right now, no one can make any forecast with any degree of reliability; not even the CFOs of the public listed companies themselves. Why? Because these are uncertain times with a vicious cycle, called a Negative Loop.

The Negative Economic Environment is causing consumers to cut down spending even further, and causing Asset Prices to decline even further. This in turn, has the effect of causing a further aggravation in the already Negative Economic Environment, and the cycle continues, spiraling down and down.

You can be sure that there will be many research analysts' downgrades in EPS (Earnings per Share) forecasts, and thus, the PE valuations. Also, as the Market PE and Industry gets cheaper and cheaper, suddenly, the historical PE valuations no longer look reasonable as well. Thus, all the perceptions change with time.

So, how then can we INVEST based on fundamentals?

Let me share a very simple formula. Of course, to refine the methodology would be even better, but sometimes, a Simplified Version is practical, i.e. useful to be applied as compared to a Rocket Science Formula that even the writer has difficulty explaining.

Here are the Rules of Simple Fundamental Investing: -

1. Good Management of High Integrity; If you don't know management well enough, you cannot invest in the stock. End of conversation.
2. Market Leader in the Foreseeable Future; it does not matter whether the stock is a market leader in terms of market share today, but it must be THE Market Leader in terms of winning PROFITABLE sales today, tomorrow, and the foreseeable future.
   
3. Stable & Reliable Forecasting of EPS; unless you can make reliable EPS Forecasts, there is no such thing as Fundamental Analysis.
   
4. Reliable Industries; select an industry that can be easily understood, and more importantly, is less cyclical, and thus, more reliable in forecasting business performance. The idea is to minimize the risk of negative shocks.
5. EPS Growth is at a minimum of 15%; there is one caveat - we must be fairly certain, and not merely guess. Research Analysts do visit CFOs and CEOs of PLCs (Public Listed Companies), and thus, if they are worth their salary, they can help you establish reliability of forecast.
6. Current PE must be not more than 8. Why? Because PE of 8 means 12.5% ROI delivered by management, which ain't that great. To invest in a stock at a PE of 12, i.e. a 8% ROI delivery, is not enough discount on its intrinsic value. Most people laugh at such stringent standards, but guess what? You find what you seek. Believe me. I have found many such stocks in the past. Why compromise with lower standards?
7. Financial Strength; Never invest in a PLC that cannot settle all its debts with a maximum of 5 years of Profit Before Tax (PBT). It is preferred that the debts are covered by a maximum of 3 to 4 times PBT. Why is this important? Because PLCs do disappoint in delivering results from time to time. We want to make sure that the stock will survive througn some tough times if and when one occurs. If PBT is halved for whatever reasons, a debt settlement period of 8 years, instead of 4, is still acceptable to the bankers. However, try talking to bankers when a PLC with a PBT Debt Settlement period of 8 times experienced a 50% drop in profitability. This means that the PLC will take 16 years to settle the debt, and in this case, the bankers may just pull the plug on the PLC.
   

Right now, the biggest challenge facing Fundamentally Driven Investors is the ability to forecast EPS with any degree of accuracy and reliability. Also, there is no EPS Growth; in fact, if anything, we can expect EPS to drop in the foreseeable future for most PLCs.

Based on these two criteria, we know that this is not yet the time to invest. Just because a stock has gone down quite a lot, or even the whole stock market has gone down quite a lot doesn't mean that it won't go down further. In the 1929 Crash, the Dow went down from 380 to about 200, but in the next 2 years, it went down to 40, i.e. it lost 90% of its total value from its historical peak.

I know what you are thinking. No, it won't happen, not this time.

Well, I've got news for you, my friend. The Stock Market is known as a FAT TAILED Normal Distribution Curve. What this means is that things that are not supposed to happen in a thousand years, happen more than once within a decade or two.

So, be very, very careful. Follow the simplified rules of Fundamental Investing, and you have minimized your risks, although, you still don't have a stop loss point where you move on when you are wrong. In my opinion, this is very important, but that is a whole basket of fish, better discussed in another blog, another time.

Meantime, be happy, stay healthy, and be nice to all around you.

Lastly, please be reminded on the Liability Exclusion Clause, which is at the top of my blog page, i.e. that the final trading decision is yours, and I will not be responsible or liable for any losses you may incur from whatsoever reason. :)

Best wishes,

Ooi

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