We Are Cautiously Optimistic : July 4, 2013

Since the start of the year, there have been many debates by investment experts on the future direction of the stock market. What is it this time so unpredictable? Reason is because nobody knows what is the impact on stock prices when Quantitative Easing (QE) is tapered or stopped. This is something new to the investment community.

So what is our view? We are cautiously optimistic. We feel that major stock indices (S&P500, Hang Seng, STI Index) may be correcting but there are still a lot of undervalued stocks in the market. So to protect ourselves as prudent investors, we had bought into stocks that are trading below tangible book value.

There are many stock investing strategies adopted by different investors. Some investors like to buy low P/E stocks, some investors like to invest based on charts, some investors like to follow the latest hot tips. From my 12 years of investing experience, there are only 2 investing strategies that I had adopted.

First strategy is to buy stocks that generate earning growth. Problem with this strategy is that when the company stops generating growth, market will punish the stock and push the share price down mercilessly. Investors who do not have discipline cut loss strategy will suffer a huge loss. This type of strategy is best use when we are at the early stage of the bull market. We do not think we are at the early stage of the bull market anymore.

Second strategy is to buy stocks that are trading below tangible book value. When stocks are trading below tangible book value, it gives investors a margin of safety. Such situation happens when a company has been misunderstood or faces a temporary problem. Share price of the company can fall hard and even fall below tangible book value. There will be a time when market starts to understand the company or problem is solved, share price will then rise significantly.

In an uncertainty market like this, most of our stock picks are based on the second methodology. We like to buy stocks that are trading below tangible book value, accompanied with strong insiders buying. It will be better if the companies had implemented share buybacks programs (this proves that even the management of the company think that their stocks are undervalued) and hopefully they pay some dividend (this will reward investors for some dividend yield while waiting the share price to go up). So if stock market continues to rise, we will participate on the bull run. And if stock market falls, our damage is minimised.

One particular sector that are we are very bullish in is US Financials. We believe that this could be one of the best investment opportunity in our generation. Subprime crisis had caused much damage to the stock market in general and particularly the banks and insurance companies in United States of America. Major banks and insurance companies are trading at prices which are only 8% to 20% from the peak. They have stopped generating losses and start generating healthy earnings. Most of such US Financials have aggressive insiders buying by the CEOs, Chairman and Directors. This is a sign that the management of the company is optimistic on the future outlook of the company. We had bought 4 such stocks into our portfolio. One such stock is Genworth Financial.

The five stages of the business cycle are growth (expansion), peak, recession (contraction), trough and recovery. We like to buy stocks when business cycle is at contraction and then sell them when business cycle is at expansion or peak. Slowdown in China had caused commodity related stocks to fall. We will be interested to buy commodity stocks if they fall further, hopefully another 20% down. We will invest, keep them in our portfolio and wait patiently for business cycle to enter into expansion stage again. One such stock is a mining company whereby the Vice Chairman had invested US$34 million to buy the shares of the company.

We are monitoring Hong Kong property sector as well. Land is scarce in Hong Kong. Falling property price is always a buying opportunity for property stocks.

We had bought into a stock that has often been called a baby Berkshire Hathaway Inc. It does have many similarities to Berkshire. They are both diversified holding companies. Over the course of the 32 years from 1979 through 2011, the book value per share of the company, inclusive of a special dividend paid out some years ago, has expanded by 18.5% per year, and the share price by 19.8% per year. As a basis for comparison, the total return on the S&P 500 during the period was 7.6% per year. Currently the stock trades below its tangible book value. So as an investor you are getting discount for the portfolio of stocks under its management. Investors for this stock come from world class hedge funds and mutual funds, include Ron Baron, Chucke Akre, Paul Tudor, Bruce Berkowitz and Jim Simons.