Monday, September 30, 2013

Investing and crystal meth: I love this shit (investing)

Spoiler Alert: Don't read if you don't want to have the ending of Breaking Bad spoiled

The awesome journey that was Breaking Bad has finally come to an end. And as a way to pay my final respects to the show, I chose to write this article about loving your craft the same way Mr. White loves his.

“I did it for me… I liked it…I was good at it…And I was really…I was alive.” –Walter White

We get self-esteem by doing something we love to the best of our abilities. Whether it’s valuing companies, grilling steaks or mixing chemicals (is that what a chemist does? Not sure), I think we can only truly be alive as men when we’re working on our craft and pushing our minds to their limits. Now I know we can’t all have the job of our dreams. But even if you have to take a job you dislike just to make ends meet, doesn’t mean you can’t find some spare time to pursue your real work, your passion, your purpose.   

For me, my craft is investing. I like how I suddenly see clearer for that fraction of a second when I realize that a bank I was analysing has the potential to be the Heisenberg of banks. I like the satisfaction I feel after making all the additions, subtractions and assumptions to figure out the true earnings power of a company. I like the tension I get when I finally made the decision to call my broker to buy a certain stock (I usually follow this up by looking up photos of my crush on Facebook and jerking off). I know it’s cheesy for me to say it, but I just fucking love investing.   

Walter White went out in a meth lab, his final moments were spent touching one of the equipment the same way you would touch the shoulder of your best friend for the last time. To go out with the knowledge that you had the integrity to be fiercely passionate and dedicated to your work, that’s what it truly means to be badass in my book. If I could choose how I would go out, it would be in front of my laptop with an annual report and an excel file open and Julia Sheer’s cover of Little Talks playing in the background.

Side note: I’m not encouraging anyone to build a meth empire and become a drug kingpin. 

Shout out: To those of you who love investing as much as I do, I wish you all the best in honing your craft. Hopefully the day will come when you can scream: 

Saturday, September 28, 2013

Risk Management: Concentration Risk

Since I started the Greedy Dragon portfolio project, I’ve only invested in stocks from the finance industry. Currently I also have exposure to only 3 countries: The United States, Indonesia and Malaysia. My portfolio is not badly positioned though as my exposures to the finance industry and to the previously mentioned countries are within the constraints I set for this portfolio. The largest asset class of the Greedy Dragon portfolio is still cash which I really hope to put to work soon to get exposure to other industries and countries. Overexposure to cash is never good over the long-term. The interest earned on your bank deposits just can’t keep up with the big bad mofo called inflation.

In my opinion, an optimally positioned portfolio would have holdings in stocks that collectively generate profits from a geographically diversified customer base. This should mitigate the risk of serious economic or political events significantly screwing up your net worth, crushing your dreams and causing you to turn to crystal meth.

You shouldn’t diversify your portfolio to get exposure to foreign countries just for the sake of diversification. Before investing in foreign stocks, a couple of things must exist: 1) The country must be financially sound, politically stable and there must not be harsh regulations preventing foreign investors from reaping profits from their investments 2) The foreign company must be able to generate decent returns on capital and be trading at a reasonable valuation. 

Another thing to remember is that you don’t have to invest in foreign companies to get exposure to other countries. Some domestic companies generate a significant portion of their operating profits from foreign markets. Banco Santander might be listed in Spain, but it generates a lot of its profits from South America.

The following is an example of a portfolio that I would consider well-diversified geographically:

Mr Worldwide Portfolio

United States  30%
China             5%
India              5%
Europe           20%
Indonesia       10%
Malaysia       10%
Chile             7.5%
Brazil            7.5%

South Africa  5%

Another form of concentration risk is being overexposed to a specific industry. To mitigate this risk, a portfolio of stocks should also collectively generate profits from a number of different industries. This ensures that the ability of your portfolio to keep generating cash to pay you dividends or reinvest for the future will not be significantly impaired in the event that changes in the forces of a particular industry destroys the profitability of that industry. For instance, those damn environmentalists might wake up one day and realize that global warming as portrayed by the liberal media is bullshit. This could cause profits in the so-called green industries to evaporate. Oh wait, they were never really profitable in the first place. Never mind..

Anyway, investors shouldn't simply diversify into any random industry just for the sake of diversification. The industries you invest in must be within your circle of competence. The company you invest in also needs to be reasonably priced regardless of the industry it’s in. Finally, there are some industries that are so screwed up that it’s probably best just to avoid them completely.

Here’s an example of a portfolio that is exposed to a well-diversified range of industries:

Portfolio B (can’t think of any lame names)
Banking            30%
Mining/Oil        15%
Technology       15%
Consumer         30%
Real estate       10%

Last but not least, there's concentration risk that's related to the individual company. The company may rely on a very small number of clients for a large proportion of its revenue. This puts the company at risk of experiencing a large drop in revenue in the event that one of its main clients switch suppliers or go out of business. If a major client goes bankrupt, the company will even have to take a large write down on its accounts receivable if it extended a lot of credit to the client. 

A company may also be overexposed to a very risky asset class. For example: A bank may have large holdings of subprime loans in its loan portfolio. The bank will suffer large losses and may even face the risk of insolvency in the event that a large number of its subprime customers default on their loans.

I agree that an investor who knows his stuff shouldn't aim to establish a highly diversified portfolio. I’m certainly not recommending that an investor hold 30 stocks, or whatever number that’s in trend with the academics these days, in his portfolio. I’m just saying that we certainly can reduce wipe out risk by having exposures to various countries and industries. I think that if a competent investor does his research and have enough patience, he shouldn’t have too many problems sculpting out a portfolio that generates above average returns with a low level of concentration risk.  At least that's what I tell myself anyway.

Wednesday, September 25, 2013

I took a position in Tifa Finance

Please read the disclaimer here: Enjoy the article, bitches!

I invested in Tifa Finance about 2 weeks ago at 210 rupiah per share. I invested in the company as it was generating above average returns on capital and trading at an attractive valuation of approximately 5.36 times earnings. The company achieved returns on average assets and average equity of 4.1% and 19.4% respectively in 2012. Tifa Finance activities mainly consists of making finance leases, especially finance leases for heavy equipment which made up approximately 64% of its finance lease receivables portfolio.

Tifa Finance has avoided using too much leverage. The company’s debt to equity ratio of 3.53 is significantly below the maximum debt to equity ratio of 10 that’s allowed by the  Finance Department of Republic of Indonesia. Tifa Finance’s low debt to equity ratio ensures that it will have more room to absorb losses before facing insolvency.

Tifa Finance also seems to have its credit risk under control. Allowance for doubtful debt was approximately 2.67%, 2.25%, 2.57% of finance lease receivables for 2012, 2011 and 2010 respectively. The company’s net interest margin of 8.19% also ensures that the company can set aside a significant amount of provisions to cover unexpected deteriorations in the quality of its finance lease receivables portfolio. Side note: The figures in this paragraph are calculated by myself and may differ from the actual figures that you may get using conventional formulas. However, I’m pretty sure that I did not employ any immoral mathematics (reference to the Swede in Hell on Wheels) and I believe my figures should be close enough. Feel free to send me an e-mail or drop me a comment if you’re interested in how I calculated those figures.

While it can be said that Tifa Finance has substantial concentration risk due to its large holdings of finance leases for heavy equipment. However, a lot of banks also have large concentrations of a specific loan type be it residential property loans, commercial property loans or etc. I don’t look at Tifa Finance’s concentration risk on a standalone basis, but analyse the impact of Tifa Finance on the overall concentration risk of my portfolio. I treat stocks like Tifa Finance as if they were items in a McDonald’s Happy Meal Set. If the cheese burger doesn’t work out, you still have the fries, coke and the toy to fall back on.   

Here’s some immoral mathematics for your enjoyment:

Saturday, September 21, 2013

Made an investment in National Bankshares

Please read the disclaimer here: Enjoy the article, bitches!

I recently took a position in National Bankshares (stock quote: NKSH). While National Bankshares may not double or triple profits in the next few years, it has a solid foundation and it throws off good and stable profits for shareholders. I can’t exactly remember at what price I bought the shares, but it probably was somewhere around the current stock price of $35.78 a share. I could look through my messages from my broker to find the exact price at which I bought the shares, but that would mean I have to get up from bed and look for my phone.

The bank generates strong returns on average assets and equity of 1.59% and 11.42% (figures are annualized) respectively for the 6 months ended June 30, 2013. The bank’s return on assets is even in line with Wells Fargo, one of the most profitable banks in the United States. I don’t know if it’s exactly right to compare a smaller bank like National Bankshares to Wells Fargo, but Buffett seems to think that it’s awesome and I think that Wells Fargo is pretty badass myself.     

Part of the reason for the bank’s strong performance is that while its net interest margin of 4.27% is higher than Wells Fargo’s net interest margin of 3.47%, it still manages its credit risk quite well. The bank’s net charge-off ratio was 0.49% for the six months ended June 30, 2013 as compared to Wells Fargo’s net charge-off ratio of 0.58% for the quarter ended June 30, 2013. The figures in this paragraph are all annualized.

National Bankshares charge-off rate hasn't only been lower than Wells Fargo's in the short-term, but has been lower over the past 5 years as well. For the 5-year period of 2008-2012, Wells Fargo's net charge-off rate was between 1.17%-2.30% while National Bankshares net charge-off rate was only between 0.1%-0.49%.

Another reason I like the bank is that it has a large deposit base to fund its loan portfolio and other investments; the bank’s loan to deposit ratio was 62.66% as at June 30, 2013. The bank also has very large capital buffer to absorb losses. The bank has tier 1 and tier 2 capital ratios of 21.8% and 22.9% respectively as at June 30, 2013; the minimum capital requirements are 4.0% for Tier 1 capital and 8.0% for Tier 2 capital. 

Wednesday, September 4, 2013

Added Bank Rakyat Indonesia to the portfolio

Please read the disclaimer here: Enjoy the article, bitches!

Last week I took a position in Bank Rakyat Indonesia (BRI), stock quote: BBRI. I bought 7,000 shares for 6,750 Indonesian Rupiah per share (or approximately US$ 0.61 at today’s exchange rate). The total cost, including fees paid to my broker, of taking this position was Ringgit Malaysia 14,848.71 (or US$4,507.22 at today’s exchange rate). 

Fuck it, I will just come out and say it: BRI is as tight as Indonesian fried chicken. The bank is super profitable and has a rather attractive valuation of around 8 times earnings only. For the second quarter ended 2013, BRI generated annualized returns on assets and equity of 4.62% and 33.05% respectively which is awesome for a bank. BRI’s net interest margin of 8.08% is better than the net interest margins of U.S. banks in general, even after loan charge-offs over the past 5 years are taken into account. BRI’s non-performing loans ratio (NPL ratio) was between 1.80%-3.52% for the five year period of 2008-2012; the loans written off by the bank were lower than its non-performing loans in each of the five years. In comparison, Wells Fargo had a net interest margin of 3.46% for the second quarter ended 2013; Wells Fargo’s net charge-off rate was between 1.17%-2.30% for the five year period of 2008-2012.

BRI have also been achieving strong deposit growth; the bank grew deposits at a compounded annual growth rate of 17.44% for the five year period of 2008-2012. In my opinion, a growing deposit base is the best indicator that the bank is expanding its business. 

BRI’s capital adequacy ratio is at a healthy 17.36% with the bulk of its capital being tier 1 capital. BRI’s strong profitability and comfortable level of capital ensures that the bank can absorb a significant amount of losses from adverse scenarios. BRI’s gross NPL ratio is currently at a manageable 1.81%.