Warning: It’s going to be a long post!
In this blog post I will address the following topics
- Stock-market valuation assessment
- Investment results
- Key lesson learned
You will quickly notice that this blog post is VERY wordy. The reason is because I want to be 100% transparent with you on what I think, what my failures/lessons are. I have 0 need to create traffic to this blog in order to earn me some advertising income, and thus 0 need to make any blog post looks like it comes out of a pitch-book of an investment banker. The key content here will be the lessons learned and the thoughts on investing.
I will start off by assessing the general attractiveness of the stock market, both the global stock market and the Vietnamese stock market. The former is made with reference to the S&P 500 which tracks the 500 biggest companies listed in the US and the latter is made with reference to the VN-INDEX which tracks all the Vietnamese companies listed in the Ho Chi Minh stock exchange – the largest exchange in Vietnam.
Global stock market:
The current US 10-year government-bond yield is 2.5%. This implies a PEx ratio of 40x (1/2.5%). Any stock being exchanged hands at around this multiple generally implies a very thin margin of safety. This is because any subsequent miss of earning growth would cause the stock’s earning yield to be inferior to yield earned from a risk-free asset such as the US government bond, and negative reaction from the market is likely. At the moment the S&P 500 – the yardstick of the very best American enterprises (and increasingly global enterprises) are exchanging hands at around 19x forward PE, implying a 110% margin of safety to the cap of 40x.
=> As such from a scale of 1 to 10 with 1 being “reasonably valued” and 10 being “bitcoin-excessively valued”, the stock market would be somewhere in the region of 1-3, with absolute certainty that it is below 5. As a result, my attitude towards the stock market in 2018 would be “mildly” defensive. (Noted however that 1 doesn’t start with “cheaply valued”, therefore being aggressive is not an option).
=> This would effectively mean that a mindlessly monthly-contribution to equity index funds/equity active funds/stocks, at 100%-0% equity-bond allocation would look very unwise, but so does a 50% – 50% equity – bond (cash) policy.
Vietnam stock market:
The current Vietnam 10-year government bond yield is 5%. From a perspective of a Viet individual investor, this 5% is the closest to yield of a risk-free asset. The restriction for Vietnamese to invest abroad means that they will never get to actually have the yield of a risk-free asset. This implies a possible scenario where the government of Vietnam could go bankrupt on its debts and the Vietnam Dong will be worthless as a result.
However the Viet individuals are not the only ones who participate in the Vietnamese stock market. A huge chunk of trading volume is made by foreign money, mainly from foreign-domiciled funds handling foreign investment capital. These participants have the choices at the two extremes of either venturing into the unknown land of Vietnam or parking their money in the risk-free asset yielding 2.5%. As such by taking an average of 2.5% and 5% we would get 3.75%, implying a PEx ratio of 27x. At the moment VN-INDEX is trading around 17x forward earnings, 53% lower than the 27x attained by the Vietnamese-standard risk-free asset – a “thinner” margin of safety compared to global-equity assessment (53% vs 110%).
Nonetheless, it must be noted that VN-INDEX is a very biased index. It is extremely biased towards the large blue-chip stocks. If we are to take away the top 3 biggest enterprises from VN-INDEX (Vinamilk, Vin Group and Vietcombank), the PEx drops by 10% to 15.5x. If we are to take away the biggest enterprises with market cap above 1000bn VND (44m USD) the PEx drops by 26% to 13.5x.
=> So given the “errr margin of safety looks thin if we include the brightest companies” and “err margin of safety looks decent if we exclude the giants” sort of situation, then in the scale of 1-10 mentioned above I would opt for a rating between 4-6 with one of my legs stepping into the above-5 region of excessive valuation. My attitude going into 2018 should therefore be: “moderately” defensive. As of today, such defensiveness is reflected in 40% of my portfolio sitting in cash after having done significant head-trimming to the very top idea – Vinamilk, complete divestment of another top idea Sabeco and…lacking good ideas.
=> My general investment guide when it comes to valuation is to build in a margin of safety as wide as it could be. If a cap of PEx ratio is around 40x then purchases should be ideally made in the range of 20x (a 100% margin of safety built in). Likewise, 27x would imply a forward PE of ideal purchases of around 14x. Noted, however that this only applies at best to very stable and predictable enterprises. A high-growth Vietnamese company yielding 20%+ in revenue growth a year and a who-knows-how-high-it-could-then-be growth in free cash flow would make the multiple approach ineffective. Therefore this PEx guidance only serves as a cross-check after an extensive free-cash-flow valuation exercise, using my best “guesstimate” of future free cash flow from now until Judgement Day.
=> My renewed enthusiasm for free cash flow come from multiple sources, but it did highlight my laziness and poor tendency in the past to rely on crude, one-time measure of stock valuation (PEx, and the sorts). To prove to you that opting for free cash is a fruitful valuation endeavour, I would borrow a quote from Jeff Bezos – the Chairman and CEO of Amazon.com “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flow” – that statement was made in 1997, and look what it has done to Amazon in the 20 subsequent years…
Also, I have written a long post summarising my key lessons learned from Jeff Bezos here. This was part of my exercise trying to understand this formidable enterprise as a potential investment.
The global portfolio represents all of my personal savings and investments to date.
The below table shows the Compounded Annual Growth Rate of my savings from inception – November 2015 up until the end of December 2017. You will find below there are 3 methods of computing this number. The reason for 3 different methods is mainly because I contribute on a monthly basis to the portfolio as a result of my saving plan. Therefore it is really hard to compute 1 CAGR as it would require me to check up on the valuation of the portfolio at every point in time I make my monthly saving contribution.
In order to explain the 3 different methods, I will call Y as the valuation of my portfolio as at 30 December 2017. (Reader will notice that I stop disclosing my net-worth. The reason for this is because the chief commander of your author’s wealth – his mum is not happy with her son disclosing whatever he earns, saves and invests online. So no more disclosure on the net-worth. However, I will ensure the blog is as transparent as possible. I guess when you see me underperforming the market then there will be no question regarding the integrity of the investment results!)
Method 1: If every of the monthly contribution is to grow at X% from the date of contribution up until 30 December 2017 in order to get me Y (see above for exaplnation of Y) , then that rate will be 12.3%
Method 2: Assuming I contribute in similar amount of saving every month (Method 1 simply takes whatever actual amount I contribute every month), if every monthly contribution is to grow at X% from the date of contribution up until 30 December 2017 in order to get me Y, then that rate will be 11.3%
Method 3: 12.8% is the difference between Y and the total of all of my monthly saving contribution
I have also computed the corresponding rate of return given by the S&P 500 for each method.
At the moment, your author is slightly ahead of his saving plan and ahead of his targeted long-term CAGR of 10%, he is though well behind a more ambitious goal (that of many like-minded investors too) which is to advance beyond the S&P 500. The 5% underperformance as shown in the table can be regarded as my personal “tuition fees” paid to my tutor – Mr. Market to help me learn to become a better investor over time. Daily lesson involves me trying to be fearful when he’s overtly happy and to be greedy when he’s depressed.
But is it a worthwhile goal (to beat the market) to pursue? Following my acquaintance with Mr.L – a great investor whom I recently met in late 2017 (for those of you who don’t know him, please refer to this post here and here), I learned that advancing beyond the market average is only a by-product of the most important investing goal of all, and that is to “never lose money”. Not losing money or avoiding all losses has been the number one lesson advocated by Warren Buffett – my biggest investing hero of all. Just by avoiding losses, over time I will have a much higher odd of advancing beyond the average. The compounded opportunity costs due from losses would otherwise be too great for me to even dream of going in line with the market. I wish I had taken this lesson to the heart as soon as I started investing. It took me a good 2 years to ingrain this lesson in my mind.
So how to not lose money in investing? How to avoid losses in investing? The answer is to tilt the odds towards investing in companies that have:
- Numerous “economic moats” that have existed for a long time and will further widen in decades to come. Example: Pepsi with leading portfolio of branded beverage and snacks, coupled with worldwide distribution scale (see my post on Pepsi here)
- Significantly higher number of tailwinds than headwinds. Example: Visa with tailwinds coming from the displacement of cash, sped up by e-commerce double-digit adoption rate and a lack of headwinds
- Rational management, measured by past record of operating business and allocating retained earnings. Example: Berkshire Hathaway with past record of outstanding insurance underwriting, market-leading positions in partly-owned affiliates and owned subsidiaries and superior capital allocation of retained earnings as measured by consistent growth in book value
- Reasonable valuation as measured, first by discounted future free cash flow at a conservative discount rate and second by superior short-term earning yield as compared to risk-free asset yield. Example: My currently used discount rate for the next 10 years is 8% and in perpetuity is 5% as compared to 2.5% earned on the US 10-year government-bond yield
- Strong financial health as measured by appropriate amount of leverage in relation to equity. Example: Wells Fargo with a capital-adequacy ratio measured by Tier 1 capital of 12% in relation to 4.5% requirement of the BASEL III (see my post on Wells Fargo here)
The Viet portfolio represents 5% of my parents’ net-worth
The Viet portfolio advanced in total 23% since inception 06/12/2016 as compared to 51% of the VNINDEX. Of the 28% underperformance, I could pinpoint about 5% to past mistakes which comprised of 1/being taken advantage by market arbitrage (refer to this post here on part related to Masan investment) and 2/investing in less-moats-protected companies in headwind-facing industries for diversification sake (CAV, DQC and LIX).
The remaining 23% is hard to pinpoint but it could be mainly because of 1/ my poor tendency to dismiss opportunities based only on arithmetic valuation multiples and 2/ my amateur investment skill level in recognising opportunities (wrongly dismiss the whole real-estate sector because I “don’t understand them”… “well, understand them and stop being lazy!” as a friend would later call me out on this) .
Overall I feel pretty lucky that all of these mistakes were learned in a bull market rather than a bear market. The “tuition fees” this year were therefore kept low.
About the 51% gain of the VN-INDEX, it would raise every reader’s eyebrows to see a stock market rising 51% in a single year. The underlying reason is mainly because of the divestment of government-owned enterprises to the private sector, notably the divestment of SABECO – the largest beer company in Vietnam. Given the price being exchanged between the government and the private-sector institutions, often times foreign private institutions (in the case of SABECO the final price represented 45x the firm’s latest earnings, more than double the multiple of the second largest global beer company – Heineken), many of the Viet blue-chip companies saw corresponding re-rating in their valuation, which drove most of the net-worth gains of these companies in 2017.
At the beginning of 2017 my top holdings were in some of the largest blue-chip stocks. The main thesis for investing in these companies wasn’t because of timing of government-owned enterprises divestment plans but because the quality of companies I seek for could be easily found in blue-chip companies than mid and small-cap companies (although I do have stocks in the mid-cap and small-cap space).
Key lessons learned
For all of my lessons learned to date, please visit this file Lessons learned
The below are the biggest lessons learned.
Key lesson 1: When a company is concentrated in its ownership, make sure I have a partner who could represent the interest of the minority shareholders. Case study: Vinacafe
At the time of purchase, Vinacafe was valued very lowly at around 13x PE with a huge chunk sat in unused cash. I thought to myself that this was a bargain for a great business that has a dominant share in instant coffee consumption in Vietnam.
Vietnam instant coffee industry is dominated by 3 biggest players: Vinacafe, G7 (produced by Trung Nguyen) and Nescafe (produced by Nestle). Vinacafe claimed to have 40% volume share while G7 did not disclose nor did Nescafe, given the latter 2 are private companies. Growing up in Vietnam helped me to know for a fact that these 3 have dominant shares and 40% isn’t a too-high-nor-too-low market-share claim. I would expect the real stat to be far from 50% but also far from 10%.
Vinacafe was the first instant coffee brand in Vietnam, traced all the way back to the year 1968 when a French entrepreneur – Mr. Marcel Coronel set up a coffee plant – Coronel in the city of Bien Hoa, Dong Nai province. Then when the war was over, the Coronel family moved back to France and striked a deal with the Vietnamese government at the time to transfer the assets. Since then the very first instant coffee of Vietnam was produced from this very coffee plant. Until 1983, the Viet government rebranded the instant coffee package and named it Vinacafe.
Historically from 2008 to 2014 when volume details were available the company has grown its revenue slightly higher than overall growth of the instant coffee market, implying a modest share gain.
Its brand coupled with its distribution scale means a very strong set of economic moats. I looked at the pricing power of the firm and confirmed that it has raised price successfully over the years without jeopardizing volume growth. The price growth is somewhere around inflation, implying that instant coffee is not too commoditised nor highly branded product.
The tailwind is enormous for Vinacafe. Coffee consumption in Vietnam per capita is low (1.4kg per person) as compared to Europe or the US (5kg per person). With future urbanisation under way and as more people move in to mega cities such as Sai Gon or Hanoi, the capita consumption of product like instant coffee will converge to the more-developed peers. This would mean a volume growth of around 6.5% over 20 years or so. A pricing power of 3% and a 1% improvement in margin over time thanks to economies of scale would mean a FCF growth in the next decade or 2 of 11%. With such possible growth target and PEx of 13x at Dec 2016, I thought to myself this was a huge bargain.
So why did the company, of this quality, trade so low? In 2011 the company was acquired (50%) by the largest consumer good company in Vietnam at the time – Masan Group. Then another 25% was acquired in 2013 by Gaoling fund, ran by HIllhouse and controlled by Mr. Zhang Lei – a very notable figure in the investing scene in China (and soon to become my main motivation for an investment in Vinacafe). Subsequently over the years Masan continued to tender offer and acquired more shares. By the time of my investment the holding amongst the 2 groups reached 92%.
With such concentration of holding, the stock was very illiquid, and as such was excluded in the universe of stocks of many funds. There were no coverage on the stock for the last 3 years. My conversation with a broker friend at the leading brokerage house in Vietnam showed a serious lack of enthusiasm amongst the retail brokers – the chief cheerleaders of the Vietnamese stock market. Furthermore, Masan – the owner of Vinacafe by then was plagued in a series of branding-scandal that further depressed the sentiment around whatever companies owned by Masan.
I thought to myself that if a company is lowly valued just because of illiquidity and a tanned reputation of corporate owner it doesn’t justify.
But it did provide a warning. With such a large controlling stake Masan could engage in bad corporate practice at the detriment of minority shareholders like myself. Example: they could loan themselves the cash that sat in Vinacafe at a low interest rate, effectively wipe out a huge value from Vinacafe. As such to prevent this from happening, I needed a “partner” when I bought into Vinacafe.
Who can be a better partner with you than Mr Zhang Lei of Gaoling Fund (Hillhouse). Mr Zhang Lei only bought one company in the Vietnamese stock market (at least to my research on the holdings of the firm in Vietnam), and that company was Vinacafe. With a significant holding Mr Zhang Lei would effectively represent the interest of minority shareholders facing Masan, instilling good corporate governance as a result.
As such I invested 10% of the Viet portfolio right in the beginning into Vinacafe without any hesitation, making it the largest position of the portfolio. Subsequently, as I divested out from SABECO investment I reinvested another 4% into Vinacafe. Around November 2017 I had 14% of the Viet portfolio in the stock.
By December 2017, Masan tendered another offer, this time round to acquire Vinacafe in full – 100%. They proposed a price of 268,000 VND per share with 66,000 VND in cash dividend and 202,000 VND paid for each share. My initial investment was made at cost of 172,000 VND – a 56% premium to the price I paid.
Readers, please hold back your congratulations on this instant 56% gain. This is because 268,000 VND is a SERIOUS undervaluation for Vinacafe. This offer valued Vinacafe at only 14x 2018 earnings, for a company that grew free cash flow at 20% a year in the past 5 years. I, therefore opposed the price. But hey what can I do when I held somewhat like 0.00002% of the company. I was hoping Mr Zhang Lei would oppose the price too but so far news have been leaning towards that Masan would end up acquiring the company in full by Q1 2018.
My mind is dead-set on long-term wealth compounding, and to miss out on one of the greatest compounding machines such as Vinacafe by having to divest it for a short-term gain of 56% is VERY painful. 56% is only 11% compounded in ~4 years, while I think Vinacafe can compound 11% in at least a decade or more.
I sent a long email to Mr Zhang Lei asking his opinions on the price but didn’t get pass the email security firewall.
Key lesson 2: Diversification implies laziness (and future mediocre return) – Group B and C stocks
At the beginning of 2017 when I started investing in Vietnamese stocks, I grouped my ideas into 3 categories:
- Group A stocks: my best ideas. These companies tend to have more than 2 moats protecting them, good management, priced reasonably, great tailwinds and little to no headwinds (Sabeco, Vinamilk, Vinacafe, Vietcombank)
- Group B stocks: my ok ideas. These companies tend to have 1-2 moats protecting them, ok management, priced cheaper than group A, but lack of tailwinds and little to no headwind (Tay Ninh Cable Car, the 2 education book publishers – EID/SED, Safoco, Sa Giang, Masan Consumer Holdings)
- Group C stocks: my so-so ideas bought for the cheapness and diversification. These companies tend to have 1 moat, ok management, priced cheaper than group A, no tailwinds and more headwinds than needed (Lix Detergent, Dien Quang, Cadivi)
Half of Group B and all that of Group C have now gone. Partly because I realised the importance of investing in tailwinded companies, learned from Mr. L and partly because their quarterly results were poor (surprise, surprise).
All of Group A ideas remained intact with exception of Sabeco, completely divested due to valuation reason.
Diversification, like Charlie Munger said, is a hedge against ignorance, or laziness or whatever you want to call it. Sometimes on average it works out, that you won’t lose money but you won’t gain much either. Some other times, as in this case, I lost money in nearly all of them.
Took me a good 2 years to learn the importance of concentration on best ideas. “Best” means companies that I know a lot about.
Key lesson 3: You should take advantage of market arbitrage, not to be taken advantage by it – Masan Consumer Holding
Refer to this lesson here, the part where I talked about Masan.
Key lesson 4: Competitive companies having tailwinds are the key to balance between long-term compounding potential and short-term investment results – Visa
Visa has been a great investment so far. It is the largest payment processor in the world, excluding China. It handles $6 trillion worth of payments, transfers, withdrawals, all kinds of transactions that involve digital cash being exchanged from one to another. It does this by having VisaNet – its core transaction processor that can authorise 64,000 transaction messages per second! Its datacentres locations are unknown to the world, because if there is anything happened to its datacentres, ~40% of the world transactions would be at risk.
With a great tailwind behind them, and that is the displacement of cash by digital force (bank card, mobile payment, deskstop payment), at the moment, the world has about $13 trillion of cash in circulation. Assuming each $1 of this $13 trillion gets to exchange hands 4 times a year (an assumption below the number of times (13 times) cash exchanged from one to another as done by the Federal Reserve survey), that would be an additional market of $52 trillion of cash for Visa and its peers to displace. This $52 trillion is expected to rise about 3% a year to match that of world GDP growth rate. By the end of 20 years, it would be somewhere around $94 trillion. At the moment, Visa executed about $6 trillion worth of payment, followed closely by MasterCard of somewhere around $4 trillion. That would mean Visa can grow the amount of payment it handles by 9% CAGR to reach $33 trillion, or 35% market share. Then if we factor in the existing growth of the digital money it already handles, the consumer-facing initiatives like Visa Checkout, the equivalent of MasterPass and Paypal, the growth in profitability as more and more payments are executed via Visa rail, enabled by security-enforcing technology like Tokenisation, and the low risk-free rate of 2.5%, Visa therefore doesn’t look that expensive at 26x 2018 FCF, assuming an FCF growth rate next year of 15% (historically they have been growing at above 20%, for a decade).
Visa ensures that I will have a higher chance of realising good short-term investment results by it having a higher than average revenue/earning/FCF growth rate than the rest of the market and great long-term compounding potential by it having a very visible tailwind and great economic moats.
Key lesson 5: Competitive companies facing headwinds increase the magnitude of opportunity costs – Greene King, Harley Davidson and Gazprom
I was amazed by the kind of cheapness investors got to buy their shares back then, purchasing great quality companies at 10x PE sounds like a sure path to wealth!
So I started looking around for great quality companies trading cheap, and came across the 3 companies below, all based in different markets:
- Greene King: the largest pub operator and number 1 IPA (Indian Pale Ale) brewer in the UK
- Harley Davidson: the largest heavy-weight motorcycle manufacturer in the US
- Gazprom: the world largest natural-gas producer based in Russia
Greene King was trading at about 10x PE, Harley Davidson was trading at 10x FCF and Gazprom was trading around 3x PE with liquidation value higher than its market cap by 60%.
They were all, arithmetically CHEAP…
…I forgot an important lesson, that undervaluation may never get unlocked if there is nothing in the future to unlock them. All these companies were plagued by headwinds: Greene King with the slow down of UK consumer spending and the closure of pub estate due to higher beer tax and rent in the past decade, Harley Davidson with the ageing audience and its struggle to revive enthusiasm for its bikes amongst millennials and overseas audience, and Gazprom, based out in Russia, a country facing multiple sanctions, geo-political risks and a seemingly bad-corporate-governance company with none of its management held any decent amount of stocks in the company…
These alone should have raised my eyesbrows, certainly they did not. I was lured into them because of the cheapness.
…As Warren Buffet has taught himself and his shareholders 4 decades ago “One of the lessons your management has learned – and, unfortunately, sometimes re-learned – is the importance of being in businesses where tailwinds prevail rather than headwinds” – 1977 Berkshire Hathaway Letter
Key lesson 6: DO NOT rely on headline arithmetic multiple to judge whether the business is cheap or expensive, and free cash, free cash, free cash!!! – Alphabet/Amazon
The headline PEx of Amazon and Alphabet are 298x and 35x. Are they expensive?
Instrinc value wise NOPE
2 decades ago Jeff Bezos – the founder of Amazon has taught the market to focus on the amount of free cash flow pumped out by Amazon. This is because the valuation of any company is the discounted future free cash flow of it until Judgement Day. Forget the earnings, they are subjected to creative accounting. Such lesson I have learned since undergraduate but guess what, I FORGET! As Mr. L reminded me, grave mistakes are normally because we FORGET! So write them down, ingrain them in one’s mind and vouch that you will never repeat them.
Amazon’s expected 2018 Free cash flow is $22bn, while its earnings in 2017 was just $2.3bn. If you buy Amazon in entirety at $563bn – the current market cap and expected to get Amazon pay you $22bn, a yield of 4%, then it doesn’t look that expensive at all as compared to 2.5% earned on the risk-free rate. And remember, this 4% doesn’t stay there, it grows by 15%-20% a year in the case of Amazon.
And what about Alphabet?
Well I would borrow an explanation from Bill Nygren – the portfolio manager of Oakmark Fund – a great investing teacher as I come to find and admire:
“We own Alphabet, so clearly we believe it is attractively valued. Our case for the company rests on the non-earning or, in some cases, money-losing investments owned by Alphabet that obscure both the earnings level and market price for the search business. A cursory look at Alphabet—$1,025 per share with $41 of consensus 2018 earnings, for a P/E of 25 times—could easily lead one to think that the market was applying an appropriately high multiple to a very good business. But consider that the company is projected to end next year with about $160 of net cash per share that is generating de minimis income. Subtracting that from the stock price gets $865 and reduces the P/E to 21 times. Then consider the other bets—autonomous driving and artificial intelligence to name a couple—that lose about $5 per share. Subtracting a $50 per share guess of the value of those bets from the share price and adding back their losses gets to an $815 price with $46 of earnings, or a P/E of 18 times. Then there is YouTube, which is growing extremely rapidly and is believed to contribute very little to current earnings, but if valued similarly to cable TV networks based on hours viewed, would be worth hundreds of dollars per share. Will streaming revenue per hour watched eventually converge with cable? We think so. Subtracting even a small fraction of the implied YouTube value leaves a search P/E that is well below the market average”
It’s only in 1 year, and a heck loads of lessons I learned. I can’t wait to start 2018 with my head down, ready to grasp whatever lessons the market ,the teachers, the companies will throw at me.