Pilifinance Stock Portfolio Policy for mid-2016 Levels

Disclaimer: The following is unsolicited investment advice and must not be construed as a recommendation to buy or sell securities. Investors must seek professional legal counsel and invest at their own risk.

>> The Philippine stock market had hit the highest level of 8,000 in 2015 during President Benigno Aquino administration's turn-around economy with an unprecedented surge since the 2nd World War, before dipping to around 6,000 and going back above 7,000.

A new presidency enters the picture with Davao Mayor Rodrigo Duterte, bringing with him more risks than the average new comer, with proposed drastic changes to the Government structure and constitution.

>> Stated bluntly, Pilifinance thinks that current levels are unsafe for additions to your equity portfolio for the following reasons:

1) Many of the popular blue-chip issues trading at many times their earnings;

2) The country is faced with many uncertainties of the incoming presidency;

3) The unprecedented surge of the PSEi may have been overdone. With a P/E ratio of 21 venturing beyond Yale Finance Professor Robert Shiller's unsafe level of 20.

4) Foreign direct investment has continued to lag in the country, with the growth driven mainly by Aquino's infrastructure spending (which are still currently being built), the BPO industry, OFW remittances and internal consumption.

PiliFinance's investment portfolio consists mainly of Real Estate development companies and Infrastructure companies. 

>> Even if some of the less-popular issues have declined in price, the current market levels might outweigh the benefits.

>> The market has shown eratic movements in 2015-2016, and Benjamin Graham tells us that if unsure, we must "follow the side of caution".

Hence we must adopt his conservative policy:

1) No buying of stock on margin/borrowed money.

2) No additions to investments on common stock.

3) Reduction in equity holdings "where needed" to a maximum of half of the portfolio and reinvested into bonds and savings accounts.

Investors with a dollar-cost-averging plan may decide to continue or stop his periodic payments.

>> However, since interest rates have remained fairly unchanged, and savings accounts rates remain around 1% per year, still less than most dividend yields, and that stock brokerages do not earn interest, it might be wise to hold on to your holdings (that have been selected as undervalued) for their dividends.

[PSEi chart taken from the Bloomberg App]

Chapter 3: A Century of Stock-Market History - Golden Nuggets from The Intelligent Investor by Ben Graham

Here we go, the second installment of our Golden Nuggets from the Intelligent Investor! Pilifinance presents Chapter 3: A Century of Stock-Market History: The Level of Stock Prices in 1972

Chapter 3: A Century of Stock-Market History: The Level of Stock Prices in 1972

Graham used indexes, the S&P 500 its with wide breadth of companies, and the largest companies in the Dow Jones Industrial Average, to analyze the over-all performance of the market. As well as indicators with the broadest reach; earliest available records going back in time.

Graham condensed the data into annual rates of advance or average compounded rate of advance (may or may not include dividends); averages of entire periods following a characteristic trend. 

He mentioned the "Rule of Opposites" when the market was low, that the time was ripe for another bull market, and was skeptical of advances that "it may have been overdone".

Graham also condensed the data into decades figures; including over-all earnings of corporations on invested capital. He kept a weary eye on the trend of "net losses" posted by companies, the number of those being "financially troubled" as indications of the end of a boom era.

Thus Graham also watched the P/E ratio of indexes, as well as the dividend yield on the indexes. He also had his eye on interest rates of high grade bonds. 

Prices, earnings and dividends were key indicators in the market, and interest rates of high grade bonds.

Graham, like everyone else, had difficulty gauging the market, outside of his value judgements. Even if the market was historically high in relation to values, and Graham recommended a conservative stance,  it was merely a beginning of another great advance and "it was not a particularly brilliant counsel." And it continued to advance even more. And even in a bearish stance, the market advances again. Graham was sure of one thing, that it will collapse and such "heedlessness" will not go unpunished.

He urged that if unsure, the investor must follow the side of caution:

1) No buying of stock on margin/borrowed money.

2) No additions to investments on common stock.

3) Reduction in equity holdings "where needed" to a maximum of half of the portfolio and reinvested into bonds and savings accounts.

Investors with a dollar-cost-averging plan may decide to continue or stop his periodic payments.

Graham urges investors to follow a "consistent and controlled common-stock policy" rather than guessing the over-all direction of the market, beating the market or picking winners.

It is also wise to keep an eye on the attractiveness of other alternatives to common stock investment such as bond interest rates, illustrating this with his bond-yield/stock-yield ratio.

Commentary by Jason Zweig

Long-term record of stocks cannot guarantee it's future movement. The one who believes so is an ignoramus.

"The value of an investment is, and must always be, a function of it's purchase price."

The rule of opposites is that the more enthusiastic investors are in the long run, the more probable it is that they will be proved wrong in the short run.

A valuation approach of Yale Finance Professor Robert Shiller, inspired by Graham, is that stock markets tend to do better below a P/E ratio of 10, and tend to do poorly shortly after going higher than a P/E of 20.

Golden Nuggets from The Intelligent Investor by Ben Graham: Chapter 2:The Investor and Inflation

In this series of blog posts, Pilifinance brings you select, practical and concise nuggets of wisdom from Warren Buffet's idol, Ben Graham himself, author of The Intelligent Investor.

We will skip the more basic chapters (such as Chapter 1: Investment versus Speculation) assuming the reader has sufficient background on Ben Graham's work, in order to focus on the more specific and practical advice from the book. 

So here we go, the first of a series of posts as Pilifinance reads The Intelligent Investor.

Chapter 2: The Investor and Inflation

> Stocks should carry more protection against inflation than bonds, but it is not guaranteed.

[Depending on future stock performance (price and dividend) and bond interest income versus inflation.]

> There is no close connection between inflation and stocks (prices and earnings).

In the past, good business was accompanied by inflation, and poor business by deflation, but the effect of inflation on earnings is limited. Correlating the inflation and stock prices will only confuse the investor.

> Do not put your eggs in one basket because of the uncertainty of the future. The conservative investor should minimize his risks but must insure himself from large scale inflation. He can do this by having stocks in his portfolio which is the lesser of two evils, the greater evil being an all bond portfolio.

> Alternatives to common stock as hedge for inflation:

A) Gold - has no cashflow, incurs expenses for storage; earning interest on a savings bank is much better.

B) Things - paintings, stamps, coins have an artificial, unreal, precarious element on the quoted prices; hard to think of as an "investment operation."

C) Real Estate - better amount of protection against inflation but also subject to fluctuations, and errors in the purchase.

Other topics brushed upon:

Return (earnings) on equity is around 10%.

Return (earnings) on market price is usually lower, expressed in the reverse as "times earnings" or P/E ratio.

As a return on stocks, investor may assume dividend return (%) plus increase in book value (%).

Commentary by Jason Zweig

From 1926 to 2002, stocks have outpaced inflation 78% of the time. But it also means stocks failed about 1/5 of the time.

Alternatives to stocks as hedges from inflation include REITs (Real Estate Investment Trusts) as well as TIPS (Treasury Inflation Protected Securities).

The Graham Number

Being a huge fan of the father of value investing, Benjamin Graham, I am quickly delighted to learn a new valuation method to determine the fair value. I was browsing one of the investment groups on Facebook when someone posted their valuation. Every time someone posts their valuations, I get curious and I would like to know how they make their computations. 

Now having finished the book Security Analysis, Graham's first book of 900 pages, I am already quite at ease with the basic computations that Graham makes, such as Price to Earnings ratio, Book Value, Earnings per Share and Margin of Safety.

Going back to the post I saw, I quickly recognized these variables and simple calculations that I use so much and hold so dearly. I immediately understood how they are computed, except for the target price or fair value im his computation. It wasn't in Ben Graham's first book so it must be a newer concept that he'd made. I asked the guy who posted, who, in his profile was a stock broker for one of the online stock brokerages, told me that it was the Graham number. I did not recognize it right away, but I looked it up. 

The formula was simple enough and it consolidated all of my favorite variables in one simple formula!

I was excited to try and understand it.

Here it is:

(Image taken from Wikipedia)

For a more detailed description visit here: 

https://en.m.wikipedia.org/wiki/Graham_number

True enough, the formula was found in Graham's later book, "The Intelligent Investor".

Let's make a sample computation using my favorite stock CDC, Cityland Development Corporation, the builder of condominiums around the Metro Manila area.

In my case, (these numbers are highly preferential), I buy if the stock is below a P/E ratio of 10, which means it must return at least 10% per year, and if the stock is selling below its book value (net asset value). Thus, the multiplier for my Graham Number will be 10x1=10, replacing Graham's 22.5.

Thus my formula has become even more conservative. 

The formula should look like this:

     __________________________________________________

   /

\/     10   X   (earnings per share)   X   (book value per share)

Now let's try it with my favorite stock. First with Graham's original multiplier of 22.5

Looking at the financial results for 2015, Cityland Development Corporation (taken from PSE.edge website)

Book Value per Share: 1.47

Earnings per Share: 0.21

With Graham's original multiplier, I got a fair value of: P 2.64 as the maximum price I can pay for the stock.

With my more conservative multiplier, I got a fair value of: P 1.76

With CDC shares selling at around P 1.00 that would constitute a very very good buy. ;)