I tried investing in stocks back in the 1990s but dropped out for a variety of reasons. Fast forward to 2021. The stock market is a whole new world. Technology and globalization have created a lot of opportunities and information. Talk about information overload.
I know so little about investing in the 21st century. If I fumble around, I am going to lose a lot of money. I need to spend some time and effort to learn more about it and myself.
This post is an ongoing journal recording my journey as an investor.
Table of Contents
Active or Passive Investing
My initial learning objective is to become a successful investor. But what does that look like? Make money? How much? More than the average market stock market growth? Like all newbie investors, I thought it would be a piece of cake. I was wrong. I made newbie mistakes. Fortunately, my mistakes are not life-threatening. I just had paper losses and became a reluctant long-term investor. Now I just want to be a profitable investor.
I hear a lot about passive investing. The general idea is to buy a basket of index funds regularly and automatically, regardless of the market condition. The argument is that the stock market trends up in the long run. Passive investors should just invest regularly and grow their portfolio slowly and steadily.
I’ve been a passive investor since I started working. It didn’t really work out for me because I totally set and forget. It is way too passive. I can’t imagine totally ignoring market conditions. If the market is frothy, surely you shouldn’t keep buying high right?
The opposite of passive investing is active investing. The goal is to take advantage of short-term price fluctuations and beat the stock market’s average returns. It seems to be for full-time investors.
But are they really opposing strategies?
I came across a free Video-on-demand course by Marketwise Asia called The Insider Course to Technical Trading. The course helped me clarify my thoughts regarding passive and active investing. The course covered the different types of trading and it dawned on me that stock investing (both active and passive) is basically stock trading. The difference is the timeframe.
Let’s look at a few types of trading:
- Fundamental Trading: Fundamentalists trade companies based on fundamental analysis, which examines corporate events such as actual or anticipated earnings reports, stock splits, reorganizations, or acquisitions. Timeframe: Months or years
- Swing Trading: Swing traders are fundamental traders who hold their positions longer than a single day. Most fundamentalists are actually swing traders since changes in corporate fundamentals typically require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit. Timeframe: Days or weeks
- Scalping: Making dozens or hundreds of trades per day in an attempt to “scalp” a small profit from each trade by exploiting the bid-ask spread. Timeframe: hours
Since fundamental analysis takes so much time, once a good company is found, the investment tends to be for the long term.
Scalping requires a good grasp of technical analysis and a good feel of market sentiment and momentum. I find this challenging especially when the trading hours happen to be my sleeping time too.
Swing trading seems like a more suitable strategy. A swing trader should still conduct fundamental analysis.
Talking about fundamental analysis, most people think about value investing. The more I read about value investing, the more I realized people have different ideas what value is. An online course by Next Level Academy I attended provided a process of identifying and assessing companies worth investing in and purchasing them at a good price (this is harder to do).
1. Find Companies You Know
Identify good sources of company recommendations or analysis. There are so many websites and newsletters touting that their stock picks are the best. The one that I found to be most helpful and grounded is The Spill Newsletter.
2. Assess these Companies
The course provided a rubric to “score” the companies being assessed. It contains a set of metrics commonly used to evaluate the financial health and potential of a company. The rubric was hard to understand in the beginning. But as I practise using it on more and more companies (I keep a list of my findings and numbers in a spreadsheet), I became more confident. The metrics include:
2.1 Financial Data
Learn to interpret financial data such as earnings, profit margins, cashflow, efficiency, and growth of the companies. I use Jitta.com, Morningstar.com and Financecharts.com to find the data I need.
2.2 Economic moats
Find out if the companies possess economic moats. These are the qualitative aspects of the business. Moats can be made up of:
- Intangible assets – brands, reputation, IP rights, non-physical edges.
- Cost Advantages – scale of operations, ability to control price or cost.
- Network Effect – Value of the service increases as more people use the service.
- Switching costs – High costs associated with changing providers such as cancellation fees, high set up costs, user re-training.
This is quite challenging to do. Reading analyst reports is a good start. I started with Morningstar’s analyst reports which I have access to due to my Firstrade Trading Account.
What kind of risks do the business face. The course taught 3 main types: Authority, Science & Key people. I find risk assessment extremely difficult to do. It is also extremely subjective. As the trainer explained a risk a business face or do not face, I find myself disagreeing. I think only people in the same industry can appreciate the level of risks a business face. It is important to read widely in order to have a better understanding.
3. Calculate the Value of the Companies
Now that we have identified good companies, does it mean we can buy the shares? The Next Level Academy course said that if the current share price is trading higher than the intrinsic value of the company, the company is overvalued.
Investors should always try to buy at a discount, not when the price is high. It is similar to buying something during a sale.
But how do we know when a company is cheap? When their current share price is lower than the intrinsic value of the company. Initially, I thought there is a formula to calculate intrinsic value, like a mathematical formula, height x breadth = area. I was wrong. If you take a look at the Summary page of a stock at gurufocus.com, there are so many ways to value a company, it is mind boggling.
3.1 Price/Book Value Ratio
One evaluation method that I really like is using historical P/B ratio (price to book value) of a company. If the current P/B ratio is lower than the 3Y or 5Y or 10Y P/B, it might be a good time to invest in that company. This article: Is Price to Tangible Book Value Dead? A Full Guide to This Controversial Metric explains it well.
And then, I came across a stock that has a negative book value even though it has positive cashflow and growing revenue and profits. What gives? I found the answer here: How to Tell If Negative Book Value is a Sign of High Risk or Not.
My conclusion is that valuation findings must be triangulated. Do not act on just one metric. Check against other metrics.
3.2 Enterprise Value/Forward Revenue Ratio
The metrics I have been using only work on companies that are profitable. For high growth companies who may be growing revenue and market share rapidly but are not generating profits yet because their costs are higher than their revenues.
Dr Wealth suggests looking at the Enterprise Value/Forward Revenue ratio (EV/FR) instead.
Enterprise Value (EV) = Equity Value (QV) + Net Debt (ND)
I didn’t quite get the formula at first. How does debt contribute to value? Wallstreet Prep offers an excellent explanation using the illustration of the purchase of a house using a mortgage. The value of the house is the capital or downpayment the owner put up (equity value) + the loan amount (net debt). This I understand since I own a house with a mortgage. The value of the house is not the downpayment I made. It includes the loan value.
This is the video where Alvin from Dr Wealth explained the EV/FR ratio and the stages a loss-making growth company go through.
Basically, the lower the EV/FR ratio the better. But Dr Wealth strongly suggest making comparisons across peers. I also think making historical comparisons can be helpful too. I wonder how easy it is to calculate 3Y or 5Y EV/FR ratios?
I tried to work this ratio into my assessment sheet, but it is proving hard to do. I decided not to further the experiment. Nevertheless, there are 2 valuable concepts that I took away from this.
- Forward Revenue and Forward Earning Per Share – these are forecasts by the companies and analysts. I discovered they are available at Tradingview.com. They supplement my valuation assessment sheet because I have only been looking at past performance. Future potential and growth should strengthen my assessment process.
- Stages of Growth – I find the table below helpful for understanding how to look at companies and identifying which stage they are in.
Singapore versus US
I currently trade and invest in Singapore and US markets. It took me a while to appreciate the boring Singapore market. I have worked out different strategies for the 2 markets. The Singapore market is mature and stable. It is dominated by REITs. Many of the companies offered pretty good dividends. No wonder so many talked about dividend strategies with Singapore stocks.
The US market, on the other hand, is more volatile and exciting. Dividends are subject to 30% withholding tax. Trading more actively in this market makes better sense since Singapore does not tax capital gains.
Track My Activities and Outcomes
I love tracking. It allows me to look back at my activities and reflect on them. What did I do and why.
I created a spreadsheet to keep my valuation “homework” – companies that I have looked at. It includes compilations of key financial metrics mentioned above as well as valuations using different methods. As new financial data are released, I update the spreadsheet. It is a rudimentary way for me to keep track of the companies that I am interested in. I find myself going back to it regularly.
I also track my income, expenses, savings, investment, stock and options trading. I developed my own income and expense tracking sheet. I borrowed heavily from Stock Portfolio Tracker by Investment Moats for my investment portfolio tracking, and Options Tracker by TwoInvesting.com for my options trading.
Featured image by Michelle Badenhorst from Pixabay
This post is a work in progress. I will add to it as I picked up new knowledge. If you have found it useful, let me know by liking it, sharing it or leaving a comment.
Let me know what you think