Monday, July 26, 2010

Invest like a fisherman

Dear Investors,
After so many years, the sea is still our main source of protein. Fishing is still an important industry especially in the coastal towns. In certain villages, fishing is probably the main profession for the inhabitants.

There are various kinds of fish out in the sea and fishermen do not travel out to the sea to try their luck and attempt to catch any fish that comes around. They know what they are looking for when they go to the sea.


Market full of opportunities
While the sea is abundant with fishes waiting to be caught, our stock market also provides ample investment opportunities. What we need is to learn from our fellow fishermen. Their ability to return with a net full of fish may provide some useful lessons for us to make money from the stock market.

Every investor wants to make money when investing in the stock market. This is obvious. But most investors do not know the stock market is like the sea with many fishes and there are also constant dangers lurking.

While fishermen cannot attempt to catch all the fishes they want, investors should also not try to make every type of profit. Some stocks provide high dividend yields but low capital appreciation. Growth stocks could be more profitable due to the potentially higher price gain, but they are likely to be more volatile and their prices could plunge more in a bear market.

Politically linked stocks could be exciting from the news flow but they could also disappoint in many cases. High beta stocks may be more exciting to aggressive punters and they can swing either way. Penny stocks could be explosive but not all penny stocks are the targets of speculators.

Then there are stocks from various industry sectors such as property, technology, plantation, banking, utilities, REITs, etc which behave differently. Some investors may want to follow certain owners such as GLCs, prudent owners, gung-ho yet dynamic proprietors, or even professionally managed companies. Some stocks are tightly held by strategic investors, others have large free float with tens of thousands of shareholders. Some are popular among foreign fund managers, others are favourites among local fund houses.

Because of the different variety, some stocks are suitable for investment and some are apt for trading. Some stocks can be held for long-term investment, others are only good for short-term punt.

Savvy investors, like experienced fishermen, know where the dangers are. There are certain areas they will never attempt to go. There are certain slippery fish they do not want to catch and there are also dangerous fish not worthwhile to put their hands on.


Know your catch
Fishermen are very clear with what type of fish they want to catch before they venture into the sea. If they brought the wrong net or wrong fishing gear, they would not be able to get the right catch.

Investors intending to make money from the stock market should also be clear of what type of profit one intends to make. Most investors only aim to make money when investing. So long as there is money to be made, they do not bother with what kind of profit. When confronted with the question of what kind of profit they hope to make from the stock market, they will appear to be perplexed. To them, profit is simply just profit and they do not bother to differentiate. Because they are not selective, many a time they end up with something they cannot handle. It will be an easier decision to make if a purchase (which could be for investment, trading or speculation) started to show profit. But when the purchase ended in the red, most people do not know how to manage it.

There are three main reasons why people are at a lost when faced with losses. First, psychologically they feel painful to cut loss. Second, they are not clear with the initial objective of the trade and lastly, they do not have a clear investment or trading plan.

As such, knowing what you want and what type of profit you intend to make from the stock market is very important. The type of stock must be in line with your risk profile. Only with a clear goal can an investor concentrate on the stocks that are suitable and appropriate for the objective. In this way, investors will not mix up between investment-grade stocks from speculative stocks. The most common mistake made by most investors is to take profit on investment-grade stocks as if it was for trading and kept speculative stocks instead for long-term investment simply because the latter was losing money.


Understand the behaviour of your prey
Knowing the behaviour of your prey is very important. An impatient investor will find high dividend stocks too lethargic with smaller price appreciation especially in a bull market where some stocks may gallop like a horse. Prices of cyclical stocks such as those in property, building materials, plantation, technology, stockbroking, mining etc can be very volatile as their earnings are substantially affected by the prices of the products or by supply and demand condition. Knowing the behaviour of the stocks you intend to buy will help to avoid being “stuck” with the wrong stocks.

If a stock is pushed up by syndicates or traders without real change in fundamentals, the price appreciation is normally not sustainable. The resultant price behaviour will be like Newton’s law of gravity — what goes up must come down.


Set your targets
Before a stock is purchased, the targets must be set. Targets, in this case, mean the kind of stock as well as under what circumstances should one sell the stock.

It must be clear whether the stock is for moderate return to beat the fixed deposit rate, double-digit capital gain or a punt on a specific piece of news.

For the first objective, a high yield low beta stock is chosen as it is less likely to fall in a bear market but on the other hand, when the market gallops ahead, it will not likely run too. This is the behaviour of the stock and investors must be prepared to bear with it. Unfortunately, it is not uncommon to hear laments from investors in a bull market where many stocks were literally racing on the gainers’ list while the investors’ low beta conservative stocks were crawling like a snail. When the patience dwindled, they will dump their limping horses and chase after the winning horses to take part in the race. Such change in target halfway through the investment process is quite common in the local scene.

In the second case where investors try to make higher capital gain by buying more exciting second tier growth stocks, things may not always turn out as expected. Being invested in higher risk higher return growth stocks, the risk is when the economy turns down or when the bear dominates the market, these stocks tend to fall faster. A higher capital loss may cause jitters among some investors who may regret what they have chosen. Some may even decide to cut loss and move back to defensive stocks just to be on the safe side.

In the third case, punting on tips and “insider” hot stocks could be exciting. After a few attempts of good luck where their “tips” worked and brought them handsome profit, they are likely to get bolder and punt more in the future “tips”. Eventually, one of them ended up as a disaster and the share price plunged like there’s no bottom. Cutting loss and giving away a big portion of the previous profits is painful and the punters will most likely hold on to the stock and hope for the best. When things did not revive, not only will they give back all the profits, they may also lose a big chunk of their capital. After this episode, some will swear they will never dabble in the stock market again. This is one of the key reasons why there are fewer and fewer punters in our market.

Most of the time investors and punters did not set their target when they first initiate a position in a stock. Even if such target was set with the corresponding expectation, they did not adhere to the objective when the market cycle takes its course. When you buy a blue chip, you cannot expect the stock to do wonders and it is not going to double its price within a year.

Similarly, when a stock has achieved its objective or is no more relevant, it is time to get rid of it. If a dividend stock has appreciated by 20%-30% in less than a year without any change in fundamental, perhaps it should be sold off. On the other hand, if a growth stock jumps in price due to improving outlook, it could be worthwhile to keep further. Not only cutting loss too late is a mistake, taking profit too early is also a common blunder in investment. If the investment objective is clear, such errors could be avoided.

The biggest failure of most punters is the unwillingness to cut loss on a trading position. When a trade is initiated on a piece of speculative news, it should be clear that it is just a punt and there is no guarantee it will make money. When things turn out to be doubtful, unfavourable or when a red flag has been raised, many punters still refuse to get out. A trading stock is simply just a trading stock and it should be treated like one. It should not be mixed up with investment stocks. Likewise, a fisherman who is going to the sea to catch ikan bilis cannot change his mind when he sees a valuable grouper swimming near his boat because his fishing gear is not suited to reel in the grouper.


Segregate the stocks
A fisherman who frequently go to the sea can still throw his fishing gear into the river to catch different kind of fishes from time to time but he knows that the objective is different, the tools and strategies will also be different.

Serious investors who invest carefully can still dabble in the stock market from time to time, especially in a buoyant market, but they must know that the type of stocks is different and the strategy to be used should not be the same. For ease of differentiation, it is better to have a different set of accounts, one for investment and one for trading. In this way, a clearer picture can be depicted so that the need for different strategies can be better demarcated. Such segregation will also allow investors to compare the performances of the two portfolios.


Use the right tools
Fishermen who want to catch fish in large and dense shoals such as tuna, sardines and mackerels know that the appropriate net to use is surrounding nets such as purse seines. They may also make use of light and bait to lure the fish.

For investors, having made up the mind on what type of stocks to invest, investors should ensure that they are equipped with the right tools to handle the different type of stocks.

For investment-grade stocks, knowledge on the business concerned is paramount. Investors should understand how a company operates, where the main profit comes from, who are the other players, what is the competitive advantage of the business, can the company continue to sustain the earnings, what is the growth prospect, etc.

On top of that, it is also important to know the financial information such as dividend yield, price-earnings ratio, cash flow, asset backing, gearing ratio, etc.

In the case of a trading stock, the best tool is technical chart. If a trader is not familiar with the use of technical indicators, at least the price pattern and volume charts will provide a perspective on the position of the stock. Immaterial of what the news say, the strength of the stock is indicated in the price and volume charts.


Know the other players
Share price is a function of supply and demand. It is important to know who are buying and who are selling, as the actions of these players will influence the future price of a stock. When a share has too many shareholders, it could be difficult to move, as every upward movement will attract a large number of sellers. From the shareholder list, the 30 largest shareholders, including the shareholdings of local and foreign institutions of a listed company are shown. Regularly, the changes of substantial shareholders (>5% stake) are reported indicating the intention of these big investors.

Some stocks are favourite among foreign fund managers. When the companies concerned perform well in terms of earnings, their share prices will be well supported and the subsequent large capital gains will be the envy of many investors as foreigners will pour in more money to push the share prices further. On the other hand, if a company disappoints or misleads foreign fund managers on certain information or profit guidance, foreign fund managers will dump the stock at whatever price. The merciless disposals will cause the share price to plunge like a stone. That is the risk of investing in foreigners’ favourites.


Know when to fish
During certain time of the year, the weather is more conducive for fishermen to cast their nets. A good timing will yield better results. Those who have some knowledge about fishing know very well squids should be caught at night and not during daytime.

Investors who always chase the market tend to buy at higher prices. If they took advantage of market weakness to accumulate additional blue chips and investment-grade stocks for long-term investment, the cost of their investments will be lower. Unfortunately, most investors tend to buy when the economy is at its pink of health and when stock prices are substantially higher. From time to time, herd mentality and negative market sentiment drive prices below fundamental values and these are the windows of opportunities for serious investors.

For those who prefer to buy only when things are clearer and they do not mind to pay a higher price so long as there is less uncertainties, the strategy is more suitable for trading. Such stocks must be sold at certain point in time and not to be kept for investment.


Know your capability
Every fisherman knows his capability. There are certain types of fish which they know they will never try to catch. They know their limitation and they will operate within their means. Fishermen know they must stay away from the poisonous spines of the toadfish, the venomous barbs in the tails of stingrays and the high voltage of the electric moray eels.

Investors should not attempt to make all the profits from the stock market. Those who are risk adverse should not attempt to trade on volatile stocks such as warrants. Those who are not good at cutting losses should stay away from trading stocks. Difficult stocks that require special skills and closer monitoring should be left to professionals like stockists or professional traders. Busy executives who try their hands on volatile news-driven stocks will be at a disadvantage to others who are closer to the market.


Engage helpers
Finally, there are businessmen who invest in trawlers, the appropriate equipment and employ fishermen to catch the fish for them.

In a similar way, those who want to make money, yet do not have the time and knowledge, may also appoint the right fund managers to invest for them. The skill required in this case is to identify the right person to do the job, a skill which the owner of the trawler must also possess. Investing in unit trust funds is akin to employing fund managers to perform the job of investment.


Ang has 20 years’ experience in research and investment. He is currently the chief investment officer of Phillip Capital Management Sdn Bhd.


Written by Ang Kok Heng
This article appeared in The Edge Financial Daily, July 26, 2010.

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