Thursday, November 12, 2015

Performance of fundamental investing in a down market kcchongnz

Disclaimer: This article is written for the purpose of discussing my various process and outcome of my investing strategies basing on a fundamental approach. It is not a recommendation to buy or sell any particular stock.


“The secret to successful investing is to figure out the value of something and then-pay a lot less”
 Joel Greenblatt
In the year 2014, I have written a number of articles on my investment strategies with the stocks in Bursa. There are well documented in i3investor which can be found in my blog:
http://klse.i3investor.com/blogs/kcchongnz/
The process of selection involved in each stock was well documented with detail analysis and comprehensive report with the perspective of an individual retail investor in me. The analysis and written reports as one can see are very different from the professional analysts and investment bankers. Hence you may consider them as unprofessional as you wish, but that is exactly what I am; I am just an individual investor, with a little knowledge of investing.
Here, as sharing of my investing process and investing strategies, and compared with the outcome in less than a 2-year period to see if we can learn any lesson from them.

The market performance in 2014 and 2015
The year 2014 started with KLCI at 1853, retreating to about 1780 before continuing its uptrend to its peak at just below 1900 at midyear, and from then on it began with its downtrend. The drop was particularly furious at the end of November 2014 when the KLCI gave up 70 points in two weeks to 1674 on 16th December 2014 due to the sharp drop in crude oil price and the Ringgit against USD. About 230 points was shaved off within half a year. Many speculators and punters ran for the exits.
The market sprang a surprise recovery to about 1860 at the end of April 2015. Just when many investors felt safe to swim again and re-enter the market, the new episode of “Jaw 2” was on screens; “treng, treng, treng” and many speculators were hurt again with the broad index declining furiously to a new low of 1532 on 24th August 2015 due to the 1AMD issues, the political situation, implementation of GST, expected interest rate hike, the steep falling Ringgit, the devaluation of Yuan, Greece, the fall in crude and palm oil prices and all kinds of problems.
The charts have confirmed a bear market as we were told. Just when many investors have exited the market and vowed not to “play” the market any more, KLCI sprang another surprise uptrend and closed at 1663 today on 12th November 2015, with many low liners recovering a fair bit from their lows. Still there is a drop of about 7% of the broad market compared with the beginning of 2014.
Figure 1 below shows the movement of KLCI over the last two years.

A check with the one-year performance of the 116 unit trust funds invested in Malaysian equity as at 27th September 2015 from FundSuperMart shows a median loss of 5.7%.

My 2014 Portfolio
Table 1 in the Appendix shows my latest portfolio of stocks, My Third Portfolio, selected through the year 2014. The report on each individual stock selected were published in i3investor in my blog:
http://klse.i3investor.com/blogs/kcchongnz/
The portfolio of 15 stocks is made up of a combination of investing principles.
The bulk of the stocks were chosen using the Joel Greenblatt Magic Formula (MF). They are Prestariang, Magni, Latitude, MFCB, Padini, Pintaras, Scientex, Tasco, and Uchitech.
Some stocks were chosen using the balance sheet negative enterprise value for Kuchai Development and Graham net net investing strategy for Plenitude.
http://klse.i3investor.com/blogs/kcchongnz/45296.jsp
http://klse.i3investor.com/blogs/kcchongnz/59102.jsp
TongHer was chosen using the turnaround investing strategy,
http://klse.i3investor.com/blogs/kcchongnz/59618.jsp
Perak Corporation was chosen based on a risk arbitrage with a takeover offer,
http://klse.i3investor.com/blogs/kcchongnz/48584.jsp
And there are a couple of leveraged instruments of company warrants in MRCB and BIMB.
http://klse.i3investor.com/blogs/kcchongnz/58419.jsp
http://klse.i3investor.com/blogs/kcchongnz/49210.jsp

Outcome on return on my 2014 portfolio
This portfolio made an average return of 29.6% compared to the loss of 6.8% of the broad KLCI index, or an excess return of 37%. The winners outperformed the losers by 10 to 5 with a median return of +16.3%.
The return of the portfolio is skewed by the gain of the Magic Formula stocks; 159% of Latitude Tree, 126% of Magni-Tech, and 115% of Prestariang. Even the next biggest gainers of Uchitech (+38%), Scientex (+38%), Pintaras (+28%), Tasco (23%) and MFCB (+16%) are also all Magic Formula stocks.
The biggest loser is the BIMB warrant with a huge loss of 40%. The other company warrant, MRCB also lost a substantial 16%.
Kuchai as a balance sheet investing strategy stock still does alright with a gain of 6.7% against the loss of the KLCI of 7%, but not for the Graham net net stock of Plenitude which has a big loss of 32%.
Similarly the risk-arbitrage and takeover stock of Perak Corp didn’t materialized with the offer rejection of one of its major shareholders, Sime Darby. It lost 14%.
The turnaround stock of TongHer hasn’t turned around too with a loss of 11%, not that much though.

Lessons learned
  1. The Joel Greenblatt principle of the Magic Formula investing; i.e. invest in good companies when they are selling cheap is a very powerful investing strategy from the above experience.
  2. The balance sheet investing strategy doesn’t show that it is appealing in Bursa as shown for Plenitude. It could also be due to the slowdown in the property market in the last couple of years which Plenitude is in, or many we haven’t given it enough time for it to perform. Is this the reason why Warren Buffett has moved away from the cigar butt investing strategy to the more appealing of buying wonderful companies at reasonable price?
  3. Turnaround seldom turnaround? Or is it because of the fall in Ringgit which Tongher suffers because of its high foreign borrowings?
  4. Beware of leveraged instrument, invest in company warrants with the mind set of financial risk management, and not hoping to swing for the fence. The articles on these warrants in the links given above have explained how to use warrants as a financial risk management tool for limited downside rather than speculating, and gambling with the hope of making big.
  1. Never place too many chips when there is an offer to take a company private or some other corporate exercises as the deal may not materialize as in the case of Perak Corp. In fact it often doesn’t. It is still a risky arbitrage opportunity and hence you must have enough margin of safety. It is not worthwhile of risking $10,000 for a potential gain of RM200.

Conclusions
The Magic Formula Principle of investing has worked well in an up market with a return of a portfolio of 116% in less than 3 years compared to the return of 10% of KLCI as shown in the link below:
http://klse.i3investor.com/blogs/kcchongnz/84923.jsp
In this article, it is shown that the portfolio of 15 stocks selected by me from the beginning of 2014 at the peak of the market in 2014 based on the fundamental approach (FA), and subsequently entered into a down market, also works very well with a total return of 30%, or an excess return of 37% over the decline of the broad KLCI index of 7%.
It shows that FA works well even in a down market. However, the only strategy which worked well so far is based on the principle of the Joel Greenblatt’s Magic Formula.
The other strategies on Graham net net, risk arbitrage, turnaround stocks and the leverage instrument of company warrants do not seem to work well in the last two years of a down market.
Hence in the future I will focus more on the earnings based Magic Formula in my investing journey.
Are you interested to join my online investment course to learn about the Magic Formula to build up long-term wealth for a small fees?
Please contact me at ckc14training2@gmail.com

K C Chong

Appendix
Table 1: Return of stocks selected in 2014

*The actual numbers may vary due to the period financial statement used

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