Monthly Archives: December 2011

death of Kim Jong-il: investment implications

December 19, 2011 By in Asian economic development, Current Market Thoughts, economics, emerging markets, Strategy Tags: , , , , , , , Leave a comment

North Korean media announced overnight that its “Supreme Leader,” Kim Jong-il, had died at age 70.  He will be succeeded by his third son, Kim Jong-un, a twenty-something with little experience and limited visibility, even in North Korea.

Asian stock markets sold off on the news.  That was on the worry, I think, that the North Korean government would stage a military provocation to “demonstrate” Kim Jong-il’s leadership ability–as it did when he was being introduced as heir.

investment implications

Other than in national intelligence agencies (which don’t share their information), the outside world knows very little about North Korea.  It’s an unruly client state of China, formed artificially at the end of the Korean War–separation along social and cultural lines would have been east vs. west.  It’s very poor.  It has big armed forces, but little industry.  It has nuclear weapons–and missiles capable of delivering them at least as far as Tokyo.

I think the most likely outcome from the leadership transition–temporary saber-rattling aside–is continuation of the status quo.

It is possible, however, that the absence of a dictator fully in control of the country will prompt a push in North Korea for reunification with South Korea.  This is something that both sides have talked about, off and on, for twenty years.  And there would be some pressure in the South for reuniting communities that have been apart for half a century.  Having seen the decade of economic stagnation that followed the reunification of the former East and West Germanies, however, I think Seoul would regard this as at best a mixed blessing, or as the best of a number of unfavorable choices.

This is the only outcome from Kim Jong-il’s death that I can see as having major investment implications.

I’ve always found South Korea a difficult place to invest in.  Lots of local quirks, including sprawling family-owned conglomerates (chaebols) with opaque operating procedures, and unpredictable (to me, anyway) intrusions of government into company operations.  So I’ve only occasionally owned companies like Samsung Electronics or Hyundai Motor, despite the excellence of their products.

I don’t think reunification would change government or corporate behavior at all.  Nevertheless, it would likely spawn enormous construction projects in the North, as well as the shifting of labor-intensive industrial production away from the South and the expansion of low-end Southern retail concepts there.  These moves could generate huge profits for the companies involved and would last a long time.

This prospect would most likely merit making the research effort to identify the beneficiaries.  In fact, the economic positives of reconstruction would probably be so powerful that a less-than-level playing field for foreigners might not matter that much.

 

developing competence as an equity investor

December 18, 2011 By in buying and selling, Constructing a Portfolio, developing competence as an investor, Trading Tags: , , , , , , , Leave a comment

Zen…

The teachers of many sports or craft skills use a Zen-like scale to rate students on their progress toward mastery of their specialty.  The scale typically has four levels, that are often expressed as:

–unconscious incompetence

–conscious incompetence

–conscious competence

–unconscious competence.

…and investing

I think these classifications have some relevance for us as individual investors.  Here’s my take on each–

1.  unconscious incompetence.  This is where everyone starts out.  You know you’re smart–certainly smarter than most of the people you see on stock market cable shows.  You’re successful at your career.  You’re informed about economics.  You read the financial press.  You look at stock prices every day.  You think that’s enough.

People at this stage misunderstand two related things (at the very least I did):

–investing is a craft skill.  Almost every concept is easy to understand.  Complexity comes from the way simple ideas are repeated and combined into intricate and less-than-obvious structures.  Here, experience is more important than having a stratospheric IQ.

–the person on the other side of the trade knows much more than you suspect.  Typically, it’s someone who has served a five-year apprenticeship under an experienced professional investor and has maybe ten years of experience working on this own.  That translates into 50 hours a week gathering information about stocks.  More than that, the person probably spends most of that time focusing on a single stock market sector–or even a single industry, or a subsection of that industry.  Yes, some of these professionals actually have two years experience 7.5 times (meaning they’ve been spinning their wheels for most of their careers–thank goodness for that).  But even so, that’s 5000 hours studying the stocks they tend to buy and sell.  How good is the hot tip from your buddy Charlie in comparison?

2.  conscious incompetence.   Some people remain in stage one forever.  They either don’t evaluate their investment performance vs. their objectives or a benchmark, or their underperformace doesn’t register because it doesn’t square with their self-image.

Others–here I’m much more familiar with what starting-out professionals do that with ordinary individuals–begin to understand that this activity, like almost any other where professionals are involved, is harder than it seems.  They react to the situation in two ways:

–they stop doing the things that lose them the most money, and

–they begin to work harder at learning the ropes.  If they can, they find a successful investor who is willing to teach and who will take them as an apprentice.

3.  conscious competence. At this stage, an investor knows:

–enough accounting to read company financial statements with ease and understands the important financial variables in a company’s success

–enough microeconomics (which is mostly common sense, in my view) to evaluate a firm’s competitive strengths and weaknesses

–how to create a detailed spreadsheet to estimate future earnings (or to forecast other relevant metrics)

–from reading 10-Ks or elsewhere, the financial history of the companies and industries he’s interested in

–that his research process, and his plan for monitoring the key variables his research has uncovered, generally lead to success.

4.  unconscious competence.  This is the Zen stuff.  In sports, it’s the idea that after you’ve done enough conscious practicing, you’ve engrained knowledge deeply enough that you can/should cultivate “the zone.”  You try to stop thinking out what you intend to do and let your unconscious run the show.

In the most literal sense, I don’t think there’s a place for this in investing.  The reason?  –the activity is much more complex than any sport, so accumulated experience isn’t enough to rely on.

Nevertheless, there is something analogous.  For example:  you may encounter a new investment idea.  You know it will easily take a month or more to do the research you need to make an informed decision to buy or not (for me, it usually takes me over a year to become completely comfortable with a stock).  On the other hand, you see that the stock is already beginning to outperform as others become aware of it.  What do you do?

At some point I think every seasoned professional develops a sense of what research tasks are crucial and which amount to crossing the ts and dotting the is, and can be done after buying a small position in the stock.  In effect, you develop a feeling of confidence that a stock has a chance to be an outstanding performer that’s based in part on unconscious processing of information that you aren’t yet able to articulate consciously.

Some veteran investors (me among them) consider this a competitive advantage.  They rarely, if ever, talk about this.  On the other hand, some use “hunches” as a substitute for doing basic research work.  That’s very bad.  If investors like this are not “managed” by their subordinates–analysts or portfolio managers–they threaten to bring down whole investing operations.  Still others shy away from the idea of unconscious thought completely, and remain at stage 3.  I think it’s foolish not to use all the tools at your disposal, but such investors may simply be recognizing their limitations and acting accordingly.

buying a “hot” IPO stock

December 16, 2011 By in Constructing a Portfolio, Industry Analysis, Investment firms, Strategy, Trading Tags: , , , , , , , , Leave a comment

recent new issues

There are three recent or current IPOs that I find potentially interesting:

–Chow Tai Fook Jewelry  (1929: HK), a  Hong Kong-based jewelry chain that specializes in chuk kam (pure gold) gold jewelry, but which is expanding its offerings to include Western-style fine jewelry as well,

–Nexon (3659: JP), the Korean company that started the casual gaming craze with Kart Rider–and who, oddly enough, just listed in Tokyo, and

–Zynga (ZNGA), the creator of the Facebook game Farmville (although my interest is mostly in the fact that it’s going public at close to 100x historic earnings).

how to buy them

Suppose you want to buy one of these–or shares in any “hot” IPO.  How do you go about it?

Let’s take it as given that no ordinary retail investor is going to get an allocation of stock in the IPO itself.

Those shares normally go to the most important customers of the brokers who take the company public, not to retail investors or small institutions.  In fact, unless you’re very close relatives or friends of the top management of the company going public–and they use their influence to direct shares your way (how likely is that?)–being offered shares in an IPO in the US as a retail investor is probably a red flag.  It suggests no one higher up in the food chain wants them.  So, to mix metaphors a bit, the underwriters are forced to reach down to the bottom of the barrel to get the deal sold.  In other markets, Hong Kong, for example, there can be special tranches of stock reserved for retail investors.  But the amount of stock you will receive in a “hot” IPO is likely to be very small.

So, to participate we have to buy shares on the open market.

my rules

While every situation is a little different, I’ve found that the rules I developed for myself while I was running a tiny mutual fund in the 1980s (too tiny to get many IPO allocations) have served me well over the years.  They are:

1.  Read the offering documents carefully and try to calculate the rate of growth of future profits.  this is how you decide what price is reasonable to pay. Like any other kind of investment, understanding valuation is by far the most important factor in success.  For a US investor trying to buy a foreign stock this can be a problem, since the documents won’t be available to you (even on the internet) until after the IPO.

2.  If the stock goes down on day 1 (as ZNGA is doing while I’m writing this), that’s a very bad sign.

3.  First day trading can be very volatile.  Use limit orders, not market orders.

4.  Don’t buy the entire position on day 1.  Three reasons, two relating to attempts by institutions to game the IPO system to get better allocations of future issues:

–retail investors may place market orders, driving up the stock price

–some institutions want to be seen by the underwriters as buying stock on the first day.  They think this establishes them as serious long-term shareholders and not “flippers” (people who only want to make a quick profit on getting an IPO allocation and who dump the stock on the market as fast as they can).  Underwriters generally hate flippers, since a large amount of flipping threatens to depress the stock price on day 1, making the issue seem less successful.  So, rightly or wrongly, buying institutions hope they’ll get larger allocations of future issues as a reward.

—institutions that want to be seen as regular supports of an underwriters IPOs (i.e., they’ll take anything) and as long-term holders of everything may start to sell after a week or two, when they think underwriters won’t notice, thus preserving their A-list status.

3.  A week or two after the initial trading day, after the IPO hoopla is over and when the institutions I describe in my last point above begin to sell, there may well be a chance to buy the stock at a lower price than on day 1.

4.  Keep a list of interesting stocks you might like to buy but think are too expensive now.  Every so often–too often nowadays, in my opinion–stock markets get frightened and sell off in a crazy way.  Everything goes down; small stocks can go down a lot.

I’ve found these to be excellent times to buy the formerly hot IPO stocks.

 

 

 

Coach’s new Hong Kong Depository Receipts

December 14, 2011 By in China, emerging markets, Hong Kong, Industry Analysis, Luxury goods, Retail, Securities regulation Tags: , , , , , , , , , , , Leave a comment

Hong Kong Depository Receipts (HDRs)

I didn’t know until I was reading the Wall Street Journal this morning that Hong Kong had depository receipts (DRs).  But COH just issued one.

Sure enough, checking with the Hong Kong Stock Exchange website, HDRs have been permitted in that market since mid-2008.  Not many takers so far, however.  The HKSE lists Vale, the Brazilian iron ore company, with two HDRs; SBI, a Japanese internet-based financial, has one.  And now there’s COH (6388 is the Hong Kong ticker symbol).

what they are

The basic idea behind a DR is to provide a simple way for a domestic investor to buy a foreign stock without having to set up a brokerage account in the foreign country or to deal with foreign exchange, either in buying and selling or in receiving dividends.

The buyer doesn’t actually get a share of stock, however.  Instead, he gets an IOU (the receipt) from some financial entity, usually a bank, that holds the real shares in a depository account.  The bank handles all the necessary administrative details, like foreign exchange and the sometimes messy business of meeting the foreign country’s securities and tax regulations.

ADRs

The company whose stock underlies the DR may use the DR issuance to raise capital in a new market, where investors may well pay a higher multiple for shares than would be possible in the home market.  In the biggest DR market, the US, I’ve found this often the case–and regard it as a bad sign.  In my experience, seeing a mature company launch an ADR means it has lost its allure for more knowledgeable home market investors.  (Another important factor in ADR issuance in particular is that it circumvents the more stringent disclosure and reporting requirements that the SEC has for US-based companies.)

In the COH case, however, the firm has not created 6388 to raise new funds–after all, operations are generating $1 billion in annual net cash.  It has created a DR to raise its public profile in Greater China.

their Achilles heel

The bane of DRs, in my opinion, is low trading volume and potentially Grand Canyon-wide bid-asked spreads.  I’ve found the problem especially acute in cases, like this one, where the operating hours of the home and DR exchanges don’t overlap.  According to the HKSE website, trading in 6388 over the past five days has only totaled about US$11,000.  The bid-asked spread shown is about 2% (my experience in the US is that the spread for a stock like this could be more like 10%).  December is usually a dreary month for investors, so January will probably give a better read on volume.

worth watching

Nevertheless, COH has probably gotten more publicity in China through the HDR listing than it would have been able to buy with the money it spent to create its HDR.  The phenomenon itself it worth watching, as well.   Two reasons:

–we may ultimately reach a tipping point where having a HDR acquires a cachet that exerts a positive influence on the home market security price, and

–pioneers like COH may have a leg up on obtaining an eventual listing on a mainland exchange.