Tools & Strategies
Asset Allocation
“The reason that most individuals tend to underperform over the long-term boils down to a failure to understand risks, which include the need to diversify their resources. Or a process known as asset allocation…”
Most individuals often make the mistake of not assessing downside risks when they make their first investments.
This is especially true when they take the first tentative steps into investing in the stock, currency, commodities markets or even buying into an unit trust.
Many tend to view their investments with a short-term perspective. More often than not, they tend to focus on the upside potential rather the risk of losses.
After all, how often have we heard of friends or office acquaintances making a quick punt on the stock market on a “hot tip”. Even if they do make quick gains, the likelihood is that these DIY or do-it-yourself investors will risk losing more of their money in the long run.
This probably explains why 9 out of 10 Singaporeans who used their CPF funds to invest in the stock market in 1999 came off worse.
That was despite the fact that the Strait Times Index rose more than 158% from a low of 800 to 2,067 between September 1997 and 1998. Most of the investors would have done better if they had kept their money with the Central Provident Fund and earned a modest interest of about 3.5 to 4.4 percent.
In contrast, most unit trust managers were able to chalk up a 20 to 40% gain with a few exceeding 100% over a one-year period.
The reason that most individuals tend to underperform over the long-term boils down to a failure to understand risks, which include the need to diversify their resources. Or a process known as asset allocation.
Smart investors do not try to second-guess all the time where the market or individual sectors or interest rates are heading.
Instead, what they do is to try to diversify or spread their investments in a manner that will help them ride the up trends while minimising losses when market conditions turn sour.
The process which they use to achieve this is known as asset allocation – a well-tested method which research has shown to be more important than which individual stocks, bonds or other investment vehicles to pick.
In fact, it has been proven that 90% of a portfolio’s performance over a long period of time can be attributed to asset allocation rather than stock picking or market timing.
The objective of the asset allocation process is two-fold :
– To reduce your exposure to investment risks while trying to maximising returns.
– To invest in a manner that will meet your future needs.
And total asset allocation goes a step further. Besides equities, bonds and unit trusts, it also takes into consideration investing in less liquid assets such as property as well as intangibles such as meeting your insurance or education needs.
Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. A chief measure, Consumer Price Index (CPI).
According to the calculation above, you need to pay $111.36 now to buy the same goods or services, which was worth $100 in 1999.
Real investment return= Nominal return – Inflation rate
Technical Analysis
Fundamental Analysis
” The crux of Fundamental Analysis lies in its attempt to determine the economic value of a security (a generic term for stocks and shares)…”
Fundamental Analysis covers the area of research that studies economics, industry and company information for the purpose of making an informed judgement on a stock’s value and its growth potential. The crux of Fundamental Analysis lies in its attempt to determine the economic value of a security (a generic term for stocks and shares).
The Focus of Fundamental Analysis
Economic Analysis covers the study of the country’s economic indicators such as new orders, money supply, stock price indices, stocks of unfinished goods, new business formations, consumer price index and unit labour costs. Important economic considerations would include interest rates and inflation and its impact on the stock market, the level of government debt, the level of corporate debts, monetary and fiscal policy.
Industry Analysis covers the structure and state of competition in the industry, nature and prospects of demand for products and services of the industry, cost conditions and profitability, technology and research requirements, the immediate and long term outlook for sales and profit.
Company Analysis
Company Analysis covers management analysis and financial analysis. Management analysis would consider the business acumen of the CEO and top managers, the past record and performance of the CEO and the corporate work ethic. Financial Analysis would consider revenue, costs, earnings of the company and the company’s capital structure as reflected by its debt to equity ratio. Financial Analysis in the form of financial ratio analysis compares the company’s current stock price to its earnings, dividends, and assets. Theses financial valuation ratios and then compared the financial valuation of other companies in the same industry to identify overvalued and undervalued companies in terms of earnings, dividends and assets.
The Father of Fundamental Analysis
A discussion of Fundamental Analysis would be incomplete without giving recognition to Benjamin Graham who is hailed as the Father of Fundamental Analysis. Benjamin Graham taught finance at Columbia University and authorized two books. His first book “The Intelligent Investor” is considered an investment classic. His second book ” Securities Analysis” is considered the bible of the Fundamental Analyst. Benjamin Graham taught Warren Buffet, Charles Munger and William Ruane. It is not coincidental that Graham’s students are considered as icons in the world of investment but rather it is a glowing testimony to the efficacy of Fundamental Analysis as a method of investing.
Types of Fundamental Analysis
Although it is generally accepted that the aim Fundamental Analysis is to determine the economic value of a security, it is the practice of Fundamental Analysis that gives rise to two sub types namely Macro-Fundamental Analysis and Micro-Fundamental Analysis.
Macro-Fundamental Analysis: The Top Down Approach
Macro-Fundamental Analysis focuses on broad economic factors that affect the stock market as a whole or industry groups of securities. This approach is known as the Top Down Approach of Macro-Fundamental Analysis. The practice of Macro-Fundamental Analysis starts at the overall performance of the economy, its impact on industry groups and finally down to specific companies in the industry groups.
It is noteworthy that Macro-Fundamental Analysis has a more formal and structured approach and as such this approach is much favoured by research departments of investment management companies and brokerage houses.
Micro- Fundamental Analysis: The Bottom Up Approach
Micro-Fundamental Analysis starts by considering the current price of a stock and compares it to measures of value. Hence the current price of a stock is compared to its dividend, its earnings, and to its assets resulting in valuation ratios such as its dividend yield, price to earnings ratio and its price to asset ratio. The resultant valuations enable comparisons to be made amongst stocks in the same industry groups and undervalued and overvalued stocks are identified by comparisons to the industrial norm. after this phase of analysis, the Micro-Fundamental Analysis attempts to predict industry and economic developments that may positively or negatively impact the stocks current price.
It is pertinent to note that investment icons such as Benjamin Graham, his prodigies Warren Buffet, Charles Munger and William Ruane tend toward Micro-Fundamental Analysis.
Conclusion
Fundamental Analysis is a structured and formal approach to research on a stock’s value and its potential growth. This analytical procedure facilitates the identification of overvalued and undervalued stocks relative to their earnings potential, dividend income potential and to their asset values, against the backdrop of the economic and industry environment. On the basis of the research, investment decisions are made such that the odds are stacked in favour of the Fundamental Analyst.
By Mr Robert Tay
Mr Robert Tay is a Dealer’s Representative and has obtained a BA from NUS and MBA from University of New South Wales, Australia. His career in the financial sector spans 25 years of work experience. He lectures regularly at SGX, IBF, NUS and SIAS. He is a member of SIAS Investor Education Advisory Committee
There are various sources of information. The most accessible are:
– The company’s annual report
– SGX’s Pulses Magazine
– The Company’s Website
– ShareInvestor.com
– Yahoo.com
– Reuters.com
– Bloomberg.com
Your friendly stockbroker’s research report
Cash flow Evaluation – this indicates the long-term viability of a business
– Profit Growth. Can the company and its business grow revenue (sunset, star, Porter’s model)
– Managing debt and expenses e.g., Keppel Corp manages its debt well and SIA its expenses.
– Value Investing. Undervalued situations use discount to book value where share price is compared to the stock’s intrinsic value
– Cash Cow. Look for cash generating companies, and dividend policy, eg Haw Par Healthcare, SPH, Chuan Hup, SembMarine, Keppel Corp
– Management, governance, execution, good and poor (foul-up)
– It is easier said than done
– There will be millions of Warren Buffett if it is that easy
– Everyone can be their own fund manager
Pair Trading
“Pair trading”, a market neutral strategy (meaning that the direction of the overall market does not matter), can help reduce portfolio volatility and improve money-making opportunities in volatile markets. Developed in the mid-1980s by quantitative analysts (quants), the strategy involves selecting two highly correlated stocks and then matching a long position in one of the two stocks with a short position in the other.
