Sunday, February 26, 2017

Long-term profitability

Hey yo, I hope things have been working out for y’all. As value investors we are always looking for companies that can generate consistently strong profits over the long-term. As the big man Warren Buffett said “If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.” In this article, we’ll be looking at some of the clues that point to long-term profitability for a company.

A strong brand is definitely up there as a competitive advantage that can help a company maintain its profitability. The Apple brand makes the company’s products appear special and allows Apple to still make YUGE profits even as the smartphone market is entering the maturity phase (Tim Cook, who probably leans left, is gonna be pissed at me for using Apple and a word associated with Trump in the same sentence). On the other hand, the HTC’s of the world has seen their profitability fall off as competition intensified and smartphones become more commoditized.

A low cost structure helps protect the profitability of companies selling undifferentiated products. For instance, oil companies with high cost structures got fucking curb stomped when oil prices collapsed. However, there were oil companies that were able to operate within cash flow or even generate free cash flow due to their low cost structures. These companies’ low cost structures could be a result of acreage with good geology, ample pipeline capacity to transport their oil, proximity to distribution hubs, a low level of debt and/or a culture that prioritizes innovation and cost cutting.       

One good predictor of consistent profitability is if the company has little to no competition. This could be a result of the company owning assets that are difficult to replicate aka trophy assets. For instance, it is very difficult to build a major oil or natural gas pipeline in the US due to all the regulations and the democrats pandering to hashtag campaigns from those damn environmentalists (things are starting to get better now that the republicans are in charge with the Dakota Access Pipeline receiving final approval). This turns certain pipelines already in the ground into not just cash cows, but big fat Kobe cash cows. A company could also dominate its market by creating such a great product that most consumers just choose to use its product. Examples of such companies are Google & Facebook. The government can also grant monopoly power to companies by giving them exclusive licenses to conduct certain types of businesses in the country. Great intellectual assets can prove to be quite the money maker. Disney will probably continue to make pirate shiploads in royalties from the sale of Elsa dolls, backpacks and clothes for many years to come. After all, Elsa is a pretty awesome gal.

There are also industry-specific stuff that investors need to take into account when analyzing the ability of companies to increase profitability over the long-term. A property developer’s ability to sustain its profitability depends on its current land bank and its ability to acquire new land at reasonable prices. For an oil company to grow its volume, it would need an ample inventory of drilling locations that are economically feasible at current oil prices. Pharmaceutical companies can make a lot of money from drugs under patent protection. So, it would behoove them to have a robust R&D pipeline of promising drugs to replace their existing patents when they eventually expire.  

We’ve all read about how Netflix ate Blockbuster’s lunch, or how the camera industry has shrunk dramatically as Asians could just use their phones to take photos of their food (we truly are living in a brave new world). Obsolescence is a threat that investors should always be on the look out for. While it’s kind of a stretch to say that brick-and-mortar stores are obsolete, the impact of online shopping is very real for many retailers. Quite a number of retailers have seen their profits and stock prices plunge as they lose sales to online stores. To be competitive, traditional retailers need to develop and execute an effective omnichannel marketing strategy.    

One of the best ways to make that “fuck you” money is to invest in shares of companies with superior and growing profits, at reasonable prices, and hold them forever. That is why it’s important to learn about the competitive advantages that lead to long-term profitability, and the threats to a company’s profits. Thank you for reading. Take care and stay rational.

Monday, February 20, 2017

Can you retire on RM300k in Malaysia?

Hey, what’s crackin’ my value investing homeboys. You and your friends probably had discussions at mamaks or hipster cafes about how much investable assets you would need before you can quit your job to pursue your passion (whatever the fuck that is). That figure could be RM500k, a million, or more depending on how baller your lifestyle is. But to accumulate RM500k or more in investable assets indicate some degree of successful financial planning. But what about the guy who didn’t give much thought about retirement until one day he realized his erection isn’t as hard as it used to be?

Update on the Greedy Dragon portfolio: I recently sold 50 shares in Natural Resource Partners for USD 40.80 per share. I still own 200 shares in Natural Resource Partners.

Let’s call our carefree, live for the moment kinda guy Ah Chong (the most generic Malaysian Chinese name ever). Ah Chong is just your average guy earning an average salary. Therefore, he has average EPF savings. In 2015, EPF active members’ average savings at age 54 was RM194,438.37. This doesn’t include EPF’s annual dividend, so it’s more like RM206k if we assume a 6% dividend. Ah Chong wasn’t into the whole savings thing in his younger years. He bought a Japanese car the moment he saved up the down payment, and has been changing to a new model every 5 years or so. He always had the latest phone and a Prada wallet like every other fucking yuppie. Ah Chong regularly visits a KTV lounge and makes 2 trips a year, one to Genting and another to Bangkok. Playa gotta play, right? Thankfully, Ah Chong was nagged into buying a house by his parents. Ah Chong got a wake up call in his mid-forties when some leng lui called him “uncle.” Since then he managed to put aside about RM100k.

A quick disclaimer: I’m not a professional financial advisor, I’m just an asshole that no one wants to employ. Nobody should take anything I say seriously as there’s a chance that I will get some things wrong.

The first order of business for Ah Chong would be to set aside some money in fixed deposit for emergencies. So, let’s say he allocates RM20k for a fixed deposit that pays 3.5% a year. According to data I got from Ringgit Plus, at least 4 financial institutions offer interest rates of 3.5% or higher depending on stuff like deposit period, your age and deposit amount. Ah Chong then splits the remaining 280k evenly between bonds and quality dividend paying stocks. You need them stocks as they have the potential to increase earnings and, therefore, their dividends to help you keep up with inflation. You need bonds as they can be a  more reliable source of cash flow than stocks. If you're interested in bonds, you can check out my article bonds is love, bonds is life.

Considering that Maybank has a trailing twelve month dividend yield of 5.9%, I think it’s quite likely that an investor can put together a stock portfolio with a dividend yield of 4.5%. Disclosure: I own shares in Maybank. I believe an investor in Malaysia is able to get a distribution yield of 4.7% by investing in bond unit trusts*. So, this would leave Ah Chong with a portfolio yield of 4.53% which would in turn give him an income of RM13,580 per year or RM1,131.66 per month.

*I looked at data from 6 different bond unit trusts. They had yields of between 4.17% and 6.88%, and an average yield of 4.97%. I adjusted the 4.97% down to 4.7% to take into account any sales charge. I calculated the yields on my own which differs from the yields displayed on the factsheets.

Assuming he spends RM500 a month on stuff like electricity, internet and petrol, that would leave him with about RM20 a day for food. That would suck for a wide fella like me who loves good food, but I guess it’s workable if you’re thrifty when it comes to food. Ah Chong will have to go to government hospitals if he needs any significant healthcare. He would also need to pay for stuff like car insurance, road tax, property assessment tax and homeowner insurance. Let’s say that all these things come up to RM4k per year. Let’s assume that the stock portion of his portfolio appreciates by 3% per year, and he sells stocks equal to his capital gains. That would allow Ah Chong to increase his yearly income by RM4,200. So, it seems our boy got things covered, right? Well, not quite. First off, he impairs his portfolio’s ability to keep up with inflation whenever he sells stocks. Secondly, stocks don’t always go up, there will be negative years.

Can’t Ah Chong just dip into his principal to combat inflation? Let’s assume that stocks go up by 3% every year like clockwork, which brings his portfolio’s return up to 5.93%. How long will it take for him to deplete his retirement fund if he increases his year 1 annual withdrawal of RM17,780 (13,580+4,200) by 3% a year. After plugging in the numbers into some Excel model I got online, it would appear that our man will run out of money within 22+ years or when he’s 77 years old. With medical advances being able to turn us into fucking RoboCop, I think that there’s a good shot that someone would live way past the age of 77.

Maybe a single guy like Ah Chong could really retire with RM300k in investable assets if he further reduced expenses such as giving up his car. But I think he would be cutting things a little too close. Ideally, you would want a retirement portfolio that generates income significantly above your expenses so as to give you a margin of safety from shit like recessions and periods of high inflation. Dipping into your principal should not be a common occurrence, it should only be done in the down years when the income generated can’t cover your expenses. I know, I know... things don’t always work out the way we want.

I would advice Ah Chong to continue working until he is at least 60. Without even counting additional EPF contributions, his EPF savings would grow to around RM275k assuming EPF pays a 6% dividend in each of the 5 years. He should also work after he is 60 (maybe he can help his best friend Ali sell nasi lemak kukus at night). It would help his finances and keep him mentally active. You get self-esteem from working and being productive. You don’t have to give that up just because you hit a certain age. Take it from me. I desperately want to work, but so far nobody wants to give me a chance. Aight guys, I’m bouncing. Thank you for reading. Take care and stay rational.