Tuesday, October 21, 2008

Keep your style, fade your fashion

It's simply not fashionable to invest in debt-ridden companies now.

Investment are like clothes. There are investments themes that come and go with the vicissitudes of fashion wear. From my short history of market experience, I already can see the different main fashion themes which are hot at different periods.

In the bull market, there are many many themes. Sector rotation, I think that's what they call it. I used to pay attention to companies belonging to a certain sector, like construction plays, oil plays, property plays etc, and look out for companies in those sector that had not run up. I had the misfortune to take part in the construction play leading right to the end of year 2006/2007 and consequently became the last fool holding the unwanted babies. Despite the many themes, the underlying premise of buying is based on PE.

Let me explain. When the market conditions are bullish and prices of stocks are breaking their 52 week high, it's simply not fashionable to invest in P/B kind of stocks. PE values are all time high, so to entice investors to put their monies, low PE stocks are trumpeted as the next growth stock to run up. I've not personally seen another metric used in bullish times locally, which is Price to revenue P/R ratio, though I read that in the telecom/dot.com era in 1990s, there are plenty of such analysts keen on this metric. It's not unexpected isn't it? When prices are so high, and earnings haven't begun to catch up on the prices, the best way to show value is to use some metrics that are independent of the earnings and/or profitability of the companies in question, but instead based on the rapid growth of the companies (never mind profitability, it'll catch up).

However, when the tide turns in a bearish market, fashion police of the investing realm dictate that P/B becomes the new yardstick of measurement. Book value defined as total assets - total liabilities, becomes the fashionable thing to valuate companies. We hear of analysts saying about the P/B of banks or properties counters or reits or whatever being at all time low, compared with SARS, Asian financial crisis, dot.com era or other similarly bearish times. I reasoned that this is the case because the market price of the company are supported by the assets owned after all the liabilities are paid to creditors. As such, P/B ratio becomes the valuation metric of choice when market conditions are bad.

The current aversion towards debt-ridden companies resulted in the relentless selling across the board of such companies regardless of business economics. Shipping stocks seem to be whacked hard for being in the wrong kind of business in the wrong time. S-shares, which are singapore listed china companies, are whacked down hard after the scare by Ferrochina and China painting & dyeing company. That means if you're a s-share and a shipping company, you're doubly screwed. YZJ and Cosco are two examples that spring to my mind.

I also noticed that dividends, ignored during bull market, are back in vogue when times are bearish. Analyst are always touting the high dividend yield of certain companies as being defensive. Reits, most showing double digits yield, are sold to investors as offering higher yields than the miserably low interest rates offered by savings account. The reason we don't talk about dividend yields during bullish times is two-fold - first being that the prices are marked up so high that the yields are nothing to boast about. Second, the capital gains from sheer price appreciation is much more tempting and lucrative than the steady and slower dividend gains.

Here's a summary of some of the metric mentioned and the times they are in vogue:

1. Price earnings ratio P/E = bull
2. Price revenue ratio P/R = bull
3. CAGR growth or CAGR revenue % = bull
4. Price to book P/B = bear
5. Cash per share = bear
6. Dividend yield % = bear
7. Liquidity ratios like current, quick, gearing = bear

One can take advantage of this whimsical swings in the investing realm in two ways. The first is to trade (long/short) the fashion trends by identifying possible candidates. For example, after ferrochina announced its death note, a few days in a row, s-shares was shorted furiously down to crisis levels, especially those debt ridden companies. Another way to take advantage of this is to always prepare one's portfolio for the bear. Chasing the price of companies so as to ride on its growth story is not exactly preparing for bearish times.

Fashion fade, but style is forever - Yves Saint Laurent

Have your own style, don't keep chasing after fashions. By the time the fashion magazines announced what is the hottest for this season, that season is over. Don't be caught wearing last season's wear.


PanzerGrenadier said...


I've felt that for making money (be it investing or trading) being contrarian tends to work although it takes lots of guts to do so to overcome the herd mentality that is so much associated with "fashion" type of investing.

Most investors don't spend enough time understanding their own tolerances to risk as well as their own GREED and FEAR factors that will impact if they give in to panic buying/selling.

Developing one's own style requires understanding one's own personality (warts and all!).

How many of us bother to do that? :-)

Be well and prosper.

la papillion said...

Hi PG,

Oh I agree with that! As it is now, i'm forming my own philosophy towards my own investing. It takes both time and effort to analyse one's own mistakes and risk profile, not something that can be done in a 10-15 mins survey MCQ :)