Humble and conscious - to retrospect

It is the overheated period whenever the wealth effect of the stock market has fueled nearly everyone's mind. How is your feeling? Do you feel that it is so marvelous to earn such a large amount of money easily? Congratulation!

By the way, if you have achieved that, it should be about the time to retrospect...

- First of all, did you notice some prerequisite before the investment in the financial assets?

Notice the health, as you may not do enough sport and care about the eating habit to maintain the healthy status. DO NOT look down on some minor health problems. Some of the health problems become prevailed recently because of the highly intensive business environment and in addition, the concentration on the "game".

Notice the education, as you may not be fully equipped yourselves with the two aspects in education. First, nowadays the hard skill like the information technology is indispensable. Do you equip yourselves with adequate knowledge in the information technology? The computer programming can let you carry out the job effectively. Second, the soft knowledge from the ancient wisdom and history is enlightening. Do you try to digest this and develop the sensible philosophy in living? Do you try to practice your language skills, communication skills, and coordination skills as the foundation?

Regarding the investment, do you learn any thoughts from the economics, politics and psychology? Do you read the publication from the investment guru to develop your own point of view? What do you respect, the statistics, your instinct, or the mixed? Do you try to lay out your own investment / trading system and procedure? Do you carry out certain backtests? Even if it may be impossible for you to accomplish all the above setup, do you try to consider your strength and weakness in investment? Actually they can work well for both the financial asset investment and the general practical issues.

- After all, how to control the feeling of pride

After the success in the battle (the overwhelming success is the financial freedom), how to cope with your money? Will you go to the restaurant to order the extravagant meal, and you can only consume small amount of food? Therefore, do you realize the virtue of frugality? Have you tried to think of the utilization of the money? After earning much money, to what extent do you care? Economics indeed concerns the enhancement of private happiness to be beneficial for the society, but do you really believe that the absolute selfishness works? Instead, do you try to have compassion on the weak and the poor? The grandfather of Spider Man once quoted the proverb where the more ability you get, the more responsibility you should have.

Have you ever developed your own interest? Have you tried to develop the good relationship with your intimate family?

- To conclude

It is crucial that whether you accept the rationality of market or follow the irrationality to carry out noise trading, to keep humble and conscious is the fundamental base. How many people could really pursue that? Do remember that you need to cope with the war of the entire life, not to win a battle but lose the war.

Glance at the extreme overbought situation - second round

(This article continues Glance at the extreme overbought situation - first round. The content below is mainly for information sharing purpose. As the guideline, it is important that one should also scrutinize your own ability and financial strength for decision. Read the disclaimer.)

My technical indicator has shown that the bounce situation has lasted for more than two weeks. The recent strength has been weakened substantially and it is apparent that the dip today is significant to see the change of trend. If the HSI and HSCE continue to dip for more than 600 points tomorrow, then the signal will finish my target round trip, i.e. a trip going from the start of the warning range to the end of the warning range.

- To sell

According to my previous action, I would like to sell some stocks for safety. My two kinds of methods to sell stocks are 1) Sell whenever it is higher in order to maintain reasonable stock-cash ratio; 2) Sell when the round trip stated above takes place. Before August, I used the first resort, while for the recent surge, I used the second one since the structural change is significant (This can also be shown in my indicator through some secondary signals.)

As for the other indicators, another set of long-run window (let's say 150-day and 250-day) indicator shows that the HSCE has reached the historical high since 1993. I also listened to an experienced commentator and entrepreneur where he mentioned the importance of money at this moment. The Australian dollar, New Zealand dollar, Canadian dollar, and EURO against the Japanese Yen start developing the round top such that the round trip pattern also occurs* (US dollar is too weak thus not applicable as the reference now).

- To possess

However, it is only the second round in my indicator. Will the stock market, especially when the Chinese side behave like the period from late 2003 to early 2004? In that period, my indicator could surge consecutively even if my indicator achieved the round trip, it still had the durability to perform another round trip. It is rare to happen. Remember that in 2003, the first round CEPA is a kind of structural change for both the economy and the stock market.

In addition, the Hong Kong dollar seems to be stronger recently. In the volatile trend developed owing to capital flow, the exchange rate between Hong Kong dollar and US dollar is relevant.

- Conditionally Change from possess to sell

Overall, should I change the strategy from possess to sell? If the above signal, i.e. dipping more than 600 points takes place and one possesses not enough money, as a kind of risk management, the flexible investors should even sell some (not all!) strong stocks in order to increase the amount of money.

Nevertheless, I have the optimistic belief on Chinese economy and impetus with discretion on policies and strategic relationship. It is inevitable that the market overshoots through the various speculative actions. If one thinks that it is really bulky to move the portfolio, just being the holder and noticing the bottom signal is more sensible and relevant.

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* Technically, the other currencies except US dollar cannot retain the strength as it breaks the support line of the upward trend against Japanese yen. As for Japan's side, even if its economy is not easy to revive, the inflation pressure due to the oil price is significant such that the pressure to increase the interest rate is great.

Application - China Com. Con.

(Here I would like to show the application of the previous discussion on PEG, Payback period and growth on China Com. Con. (1800). Detailed analyses of this company are mostly omitted.)

- China Com. Con. (1800)

Adopting the consolidated forecast for 2007 to 2009 from an investment media and the price today, we calculate the following.

Year 0 is the year end of 2006, while year 1, year 2 and year 3 are the year ends of 2007, 2008 and 2009 respectively. The others are beyond 2009.

Currently the PEG level for the targeted market, i.e. the well-known Chinese enterprises, is approximately 2. We adopt 12-year payback period as the focus. The long-term growth rate, i.e. the annual growth rate of the EPS after year 3, is derived through the current price as of Oct 18, 2007, i.e. HK$23.50.* The result shows that it is 21.5%.

- Evaluation

1) Robustness of the forecast: The forecast can be relatively stable and not easy to be changed since the price information of its product is not the instant one. The opposite case is those stocks such as the stocks heavily affected by the commodity prices, HKEX, and insurance companies in China, since their performance can be observed instantly through the volatile daily prices or volumes of their products, such as commodity futures (for stocks producing commodities or using commodities as part of the cost-of-good-sold), A-share indices (for insurance companies), and transaction volume (for HKEX). Thus the forecast should be relatively robust.

2) Long-term annual growth rate = 21.5%: This long-term growth rate reflects the relatively optimistic growth of people's expectation on its business model, even if we map our analysis on PEG = 2 /payback period =12 years. As an industry fully supported by the development policy of Chinese government, this amount is still at the acceptable growth rate. In case that the market sentiment boosts it to the unstable level but its long-run growth rate is acceptable, I regard it as relatively stable only.

One should evaluate its details including its business model, ordinary financial performance (such as its low gross and operating profit margin), generation of cash flow, management and risk (such as the surge of the material price) before any actions. Besides, the trend in the whole market, industry, and policy movement should also be well scrutinized.

Notice disclaimer for the investment decision.

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* Instead of calculating its estimated value, I would like to calculate its long-term growth rate to see if it is reasonable or not under the given price and targeted payback period.

* * *

Please notice that I re-structure the labels of the essays such that it is neater.

PEG, payback period and growth

Previously I wrote the essay about the intuition on PEG, in which the condition PEG = 1 for long-run growth can imply the payback period approximately equal to 7 to 8 years. The PEG in wikipedia also mentions that when PEG = 2, it becomes expensive. Here I provide the corresponding payback period for reference as shown in the graph below. We can see that the payback period is around 11 to 12 years when the long-run growth rate is at the reasonable range.

I would like to show some implications below.

- If payback period rule is treated as the standard

From above graph, under the reasonable range of growth, say from 10% to 20%, the investment should be attractive if the payback period is equal to 7 to 8, while the investment should be expensive if the payback period is equal to 11 to 12. If the payback period rule I state here is treated as the standard for all g, those stocks expected to have strong long-term growth rate can achieve relatively higher PEG such that maximum PEG can be even as high as 3 or 4!

- Easy to have high growth?

In reality, the payback period rule is not actually fixed, since those investments with strong long-term growth rate should be hardly sustainable comparing with the reasonable range of growth rate, i.e. those with strong growth may not have the same "durability" as those with the mild growth or low growth. Periodicity in the industry or unstable management may disturb the continuation of the strong growth (You may say that many of the growth stock may be prevailed fortunately only because of current policy and economic environment). Therefore, people are not willing to grant the standard payback period rule stated above towards these investments. Under the strong growth, the shorter payback period should be used.

Through the above graph, the loci of constant PEG decline as soon as g increases. This is a kind of coincidence that can be used to model the unsustainable risk of strong growth rate. Of course, occasionally some stocks have reputation by achieving sustainable long-term growth. They can have larger PEG on the average.

- Mixed senses

From my point of view, the above graph is the contour such that one can put the stocks on the contour according to their growth potential and risk and determine the range of PEG, thus the range of PE is also derived. The higher the certainty of the growth is, the higher the range of PEG can shift upward.

It seems to be easy, yet the long-run growth rate and the risk are difficult to be evaluated, so that some other justification has to be carried out. It is worthwhile to remember that artistic sense and scientific sense should cooperate to work out the investment decision.

(Updated at 1:03 am on Oct 15, 2007)

Value, growth investment and personality

Fundamental analysis is a familiar term for most investors. It can actually involve two aspects, the value investment and the growth investment.

- Value investment

The value investors select the value stocks by comparing the NAV and the price. The NAV has to be the effective one such that the management and the asset can coordinate with each other in order to reflect the value of the asset. The stable track records through earning and dividend are the supports.

Usually, the sole consideration of value investment is the bottom-up approach, where the undervalued property is focused by the investors first. The margin of safety should be large enough to attract the value investors to invest in these stocks. Through the general observation, the effect of market-based pricing on the value stocks (pricing through market sentiment, but not the intrinsic value) is usually small owing to the poor popularity, such that there is less correlation with the market indices.

- Growth investment

The growth investors are eager to look into the prospect of some industries. As soon as they find out there is plenty room for some products or services to expand in the market, they will try to invest in the leaders or some stocks with good management team. In this case, the past dividend may be somewhat irrelevant as it is a kind of growing business. In most of the situation, the NAV is significantly less than the stock price. The expected earning or free cash flow generated by the business is the main focus.

The growth investment relies on the top-down approach to enhance the reliability. Through the general observation, these stocks can have significant effect from the market-based pricing.

In the later development, the growth investment can combine with value investment to make value comparison or judgment. The tool used for value judgment includes the PEG ratio and the discount cash flow (DCF) model.

- Different approaches require different personalities and abilities

Even if these two types of investors carry out the fundamental analysis, the personalities and abilities to participate in these approaches are somewhat different. The pure value investment described above suits the arbitrager, engineer or accountant by scrutinizing the accounts and the business operation and doing precise value judgment, which requires perseverance in information seeking. The pure growth investment approach described above suits the fashion designer or inventor, requiring much innovative imagination and prospective thoughts.

To run the business, these two approaches coexist such that companies with sustainable growth (winged steed) and bargain value are searched. Buffett originally used the value investment by considering the intrinsic value solely, while Munger joined Berkshire Hathaway and applied the growth investment component to the decision. Buffett now regards these approaches as being joined at a hip. As described by Mr Lam, the attitude required is the personality of capitalist.

Reference: Value investing and Growth investing (Wikipedia)

Feeling of slope

(Here I provide a simple sense for our judgments on the current market status.)

I would like to share some discovery, in which the ordinary people may not observe this easily. Attached please find the HSI graph from 1969 to 2007, with the latest date on Oct 4, 2007.

With such a long time span, we can observe the whole picture of the stock history in Hong Kong. In this figure, it is shown that the massacre in 1973 and the crash in 1987 are "diminished". The remaining things that we can see are our etching reminiscence in 1997 and 2000.

As we all know that the nominal prices of stocks or indices are useless in investment, and they tend to rise exponentially according to the rate of return. To have the fair comparison, one needs to adjust the figure in the logarithmic scale in order to explore the real picture. It is shown as follow.

The picture now can reveal the larger impact of the massacre in 1973, and also shows the adjustment in 1982 due to depreciation of Hong Kong dollar. Furthermore, we can see clearly the stock crash in 1987. When we compare the previous crashes and bearish trend in 1997 and 2000 with the past crashes or bearish trends, they are not that sharp comparing with those in 1973, 1982 and 1987.

What I want to notify you here is the slopes of the bullish trends before the bearish trends or stock crashes, where I use the red dash lines to indicate. Do we find that the slopes in the previous trends are mostly steeper than the bullish trend that we currently face since 2003?* How should we position the crazy surge recently? The start or the end? There are indeed some reasons why those big players are urging people to reach the skyscraper...

Stock investment is somewhat the mixture of art and science. The above analysis requires you to utilize your artistic sense. Regarding the science sense, it has been revealed extensively through fundamental analysis, economic analysis and capital flow. After this, to participate or only appreciate depends on your risk appetite. I do not bear the responsibility for one's potential loss. Remember the signal provided in the previous essay.

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* (Added on Oct 7, 2007) The slope for the bullish trend from 1995 to 1997 is more gentle comparing with those indicated by the red dash lines. Remind to evaluate the history discreetly.

To argue whether it is the start or the end is exhausting. Notice the imminent change in our own system, i.e. the mix of fundamental and technical analysis, in order to determine the three classical ratings, i.e. buy, possess and sell signal. Currently my system is the same as before to possess, but the difference is that the bounce dynamic has taken place. Thus I wait for the forthcoming signals for further decision.