jeremyow's investing experience

Is stock investing a zero-sum game?

2012-10-14T02:16:00.000+08:00

This question has puzzled me for a long period of time since I started my journey on learning about investing. Different people hold different views to this question. Some say stock investing is a zero-sum game while others say that it is not. Is stock investing a zero-sum game?

The idea of zero-sum game implies that in every stock investment transaction, one party must benefit at the expense of another party who is making a loss. It seems that during every transaction of a stock in the stock exchange, the proponents in support of investing as a zero-sum game hold the view that one party must always benefit from the transaction from another party who is making a loss.

For example, buyer buys a stock at a particular price from a seller who sells at a loss to him. This seems true during a bear market when a seller might be selling a stock at a loss due to a down-trending market to a buyer who buys the stock at a cheaper price which later rises in price resulting in a profit for the buyer. This also seems true when a seller sells a stock at profit at a particular price to a buyer after which the stock price goes down resulting in a loss for the buyer.

However, do stock prices always behave in a zero-sum game fashion? Is it always necessarily true that one party must make a profit from a transaction at the expense of another party who is making a loss?

Through my own experience with investing so far, I noticed that any stock investment transaction on the stock exchange may not necessarily follow a zero-sum game fashion. For instance, when I sold off a stock at a particular stock price making a profit, the buyer of my stock did not make a loss thereafter as the stock price continued its climb further. In this case, both parties made profits on their transactions. In another case, when I sold off a stock at a loss, the buyer of my stock did not make a profit as the stock price continued to decline further. In this case, both me the seller and the buyer made losses together on our transactions.

Thus, it is not always in a stock transaction that one party will make a profit at the expense of another party making a loss. This is the randomness of the stock market as described by Benjamin Graham, the father of value investing that in the short-term, the stock market is a voting machine, but in the long term, it is a weighing machine.

In the long term, stocks belonging to businesses with good fundamentals may grow their value over time rewarding their investors with appreciating stock price. For example, one cannot imagine a small company that has grown over time to become a large enterprise generating larger amount of revenue, income and cash flow to be still trading at the same share price when it was once in its infancy stage of growth. Unless this company keeps issuing more outstanding shares enlarging its equity at a faster rate than the growth of its earnings to dilute its earnings per share. Then, we might see a stock price that has not grown over a long period of time as the earnings per share remains the same due to dilution effects of more shares issued over time.

Thus, the company that can steadily grow its earnings per share over time, while growing and managing well its other tangible and intangible fundamentals such as revenue, income, cash flow, margins, branding, market share, corporate governance, debt loads, debt servicing, working capital need, etc. will generate appreciating stock value over time. This is why the stock market is a weighing machine over time as time will tell the difference between a good company and a lousy one.

An investor can invest in a company at its early stage of growth and exit from the company by selling off his shares at a profit to another investor after the company has grown into a medium size enterprise. The latter investor can also benefit by staying invested with the same company which grows into a large enterprise similarly seeing the share price of the company continue its appreciation over time and making also a profit on his investments. Both investors, the earlier and latter one derive benefits by staying invested with the company that grows in value. No one benefits at the expense of the other as both made their profits on their investments.

If one is a good value investor, there is no concern over whether stock investing is a zero-sum game or not. This is because no matter which period of time he has bought his shares (assuming he always tries his best to buy at lower than his estimated intrinsic value per share of a good company securing a margin of safety), he will be rewarded with an appreciating share price over a period of time. Thus, stock investing will never be a zero-sum game for any investor as no matter at which stage of growth in the company, as long as an investor rides on the growth, he will be seeing the share price of his invested company appreciate over time as the company grows. This is on the assumption that he has invested in a good company at a reasonable share price that grows its fundamentals steadily over a long period of time.

Is stock investing a zero-sum game? By the looks of it, it is not. A company can grow over time and an investor who has invested in a good company that grows in value over time will see his shares in the company appreciate over time. Thus, stock investing is not a zero-sum game as it will reward any patient and astute investor who rides along the growth of a good company, seeing his invested shares grow in their share price over time. This is only so true of a company that grows in value instead of destroying value for its shareholders over time.

Stock investing is not a zero-sum game.

Any investor can derive value from a good company by participating at different points of its growth.

If you get the customer experience, you have the business.

2012-10-10T00:11:00.000+08:00

I am sharing a basic fundamental truth about running businesses but it is so basic that people may take it for granted. Every business exists to fulfil a need or want from the customer. If the business can understand the need or want of the customer really well and also execute their service or sale of products to meet the relevant need or want and even exceed the expectation of the customer, they have got the customer hooked. A satisfied customer means potential repeat sale and even word-of-mouth referrals by the satisfied customer for introducing more customers to the business. On the contrary, if a business provides lousy experience for a customer and keeps doing so long enough, the result is potential permanent loss of customer. This results in permanent loss in repeat sale from the same customer and also potential word-of-mouth referrals for introducing more customers to the business.

I personally have experienced this fundamental truth in business. I was once patronising a particular car servicing company. However, after some years I switched to my now current car servicing company. Ever since the switch, I have so far been satisfied with the service provided by my current car servicing company for the past few years. Why did I make the switch?

Originally, I was satisfied with my previous car servicing company. It was a car dealer company as well and my first and second used car were bought from this previous car company. When I was buying my first used car, the car company got me a medium size used car from their list of used cars. I was satisfied with my first used car and had it serviced at this same car company over a few years. After a few years, I decided to change to a smaller used car. However, when I was making my purchase decision at the same car company, I was persuaded by the car salesperson to go for a medium size Japanese brand used car because the reason given was that it will carry a high resale value should I sell the car after a few years usage.

The advice given by the salesperson was not wrong and sounded logical. I went ahead with the purchase and got a medium size used Japanese car. I continued to service this second used car with the same car company. I decided to change my second used car again after another few years. This time round, I again wanted to purchase a smaller used car. Unfortunately, the car company happened not to carry a small used car in their list of used cars at that time. The salesperson tried to persuade me to buy one of their medium size Japanese used car using the same argument again that this type of car has a better resale value.

All seemed well. However, little did the salesperson knew that I had already set my mind this time to get a smaller used car and was thinking of holding on to this third used car for a long time and will not be changing car any time soon. I did not get a chance to voice my needs to the salesperson as what I got from the conversation was just the salesperson keep talking and explaining to me the logical sense to get a medium size used car. This could be because he was eager to make a sale since they did not have a smaller used car at that point of time to sell me and was hoping I would change my mind to get a medium size used car instead.

Guess what? I told the salesperson I would go back and reconsider my decision and return to the car company to make my purchase. The result is that I never did get back to the car company again. I eventually visited another car company and made my purchase of a smaller size used car as I intended to. Days later the previous car company called me up to ask for my decision and I was sorry to disappoint them that I had made my purchase with another car company. As for my car servicing with this previous car company, you would have guess it correctly that I did not return to the car company again for my car servicing needs but changed to my now current car servicing company.

My current car servicing company has served me well. I could feel their sincerity in wanting to do their best to fulfil my car servicing needs with reasonable car servicing response time. There is also a personal touch as they actually remembered me as their client every time my car is due for servicing. Sometimes, when I asked for a discount on their car servicing, they will provide a small discount for me. Even if I am a loyal customer to them deserving a small discount, they have also done their best to keep me as their loyal customer and supporter of their service.

From my experience as a customer, the business that can understand my needs or wants better and can fulfil them better will get my sale. Sometimes, it is not just the price of the products or service that matters, but more so the quality of experience provided to the customer. I am glad to say that I have remained a loyal customer of my current car servicing company even though I received many advertisements on cheaper car servicing by other car servicing companies. Why do I stick with my current car servicing company? This is because they have provided quality customer experience so far and people tend to stay with familiar comfortable experience. Familiar quality customer experience is such a strong positive reinforcement and feedback that keeps the customer returning for more. This is a virtuous cycle that ensures repeat sale from the same customer and may even through word-of-mouth referrals from existing customers to help the business expands its customer base.

As such, the revenue of the business will grow steadily over time. The business will thus expand in size to service more customers. Then, it will be time to look at how the business can find ways to accommodate the increased customer base to maintain or even improve their level of quality customer experience. As long as the business continues to provide better quality customer experience, it will keep growing and have to constantly seek to accommodate the increased customer base and keep up their quality customer experience.

Do not underestimate the power of quality customer experience as it is a fundamental truth which obviously will make or break a business.

12 lessons Steve Jobs taught Guy Kawasaki.

2012-07-27T13:24:00.000+08:00

Twelve lessons Guy Kawasaki learnt from Apple's Steve Jobs. These lessons I feel are not only applicable to entreprenuers but are also useful for any employee who constantly want to improve at how they think and function at work. Anyone can think and feel like an entreprenuer no matter an employer or employee. Any work that one do is likely to be involved in dealing with providing goods and services to people. Even an employee working in an organisation is providing service to his employer, his fellow colleagues across various departments and also their customers (even back end support staff who think that dealing with customers is not their job is in fact providing indispensable support to their front end colleagues who deal directly with customers).

Twelve inspiring lessons from one of the World's greatest entreprenuer Steve Jobs that can be applied for everyone who wants to improve at how they think and feel in their work, enjoy!

Summary of the 12 lessons:
1. Experts are clueless.
2. Customers can't tell you what they need.
3. Biggest challenges beget the best work.
4. Design Counts.
5. Big graphics, big fonts.
6. Jump curves, not better sameness.
7. If it works or doesn't work, that's all that matters.
8. Value is different from price.
9. A Players hire A Players.
10. Real CEOs can demo.
11. Real entrepreneurs ship.
12. Some things need to be believed to be seen.

How much money does one need to reach financial freedom?

2012-07-09T01:41:00.000+08:00

In my earlier post "So you want to retire in Singapore?" under the label "Financial Planning", I did an estimation of the amount of money needed to retire in Singapore. The estimation of the retirement amount varies depending on the current age of the person. However, a conservative estimate runs in the likes of retirement funds of at least one million Singapore dollars to retire comfortably. Not many people will be able to reach this amount upon their retirement. I see around me many retirees who are on family retirement support meaning they are supported financially by their children. It comes as no surprise as not many people can have a decent amount of savings upon retirement to depend upon. Thus, the burden of retirement will have to rest upon their children.

It is good and well for children to support their parents financially in their retirement years since their parents have put in their sweat and toil to raise up their children. This is the tradition of many Asian families having their children support their parents' financial needs during their retirement years. However, wouldn't it be great if the parents do not require any financial support from their children in their retirement years? It will mean that parents have no financial worries since they are self-supporting and their children will have no financial burden to support their parents. I am not saying this to mean that children do not have the responsibility to care for their parents, but rather that it will be truly beneficial to everyone if there is no financial worry to both parents and their children if elderly parents have no need for any financial support.

Therefore, it is important for everyone to work towards becoming financially free. One will no longer have the worry of earning the next paycheck in order to survive another day of living. Working can then become a matter of choice and perhaps enjoyment, and not just one of necessity for the income that work brings. One can live a life of choices having the time to do the things that one likes to do when one becomes financially free. One can choose to engage in a work out of passion rather than necessity for the earned income. Aside from the choice to continue to work, one can also engage in meaningful activities that are beneficial for oneself as well as others. Afterall, one has only one life to live and our time is limited. Live a meaningful life.

For me, living a meaningful life means living a life for God. One does not need to be financially free in order to live a meaningful life. Financial freedom is just a platform to allow one to have extra time on one's side to make the choice to live a meaningful life.

After knowing the objective of becoming financially free is to have the choice to use one's freed up time to engage in meaningful activities for meaningful living, the golden question to ask is "How much money does one need to reach financial freedom?". In my reading, I found out a guideline that one can use. The amount of money to reach financial freedom can be estimated to be around twenty times the annual expenses of a person.

For example, if Albert lives in Singapore and spends a total of SGD$24000 in annual expenses, he will need an estimated sum of SGD$480000 to become financially free. One may raise the question of how this is possible. Afterall, if one requires a total sum in savings of at least one million Singapore dollars to retire in Singapore, how can half the amount at SGD$480000 make one financially free?

This is where the difference in having investment knowledge kicks in. The estimated sum of SGD$480000 is not going to work miracles if it is not invested and providing passive income. Due to inflation and spending, this amount is not going to last very long. However, if this amount can be invested at an annual yield of 8%, it will provide a passive income for Albert that will fight inflation and allow him to be perpeptually financially free if he maintains his current lifestyle in annual expenses without increasing his financial expenditure.

How does the SGD$480000 work out in terms of fighting inflation and still providing enough passive income for Albert? For a yield of 8%, Albert will receive $38400 annually in passive income. He must not spend all these money or else inflation will erode away his subsequent years' spending power since the price of goods and services has increased due to inflation. Instead, if Albert is financially wise and disciplined, he will set aside 3% out of total 8% annual yield religiously every year for reinvestment into his original capital sum. This reinvested amount will keep growing his original capital sum in order to receive more passive income in every subsequent year to fight the effects of inflation (assuming long term annual inflation rate at average of 3%).

The remaining 5% out of total 8% annual yield then works out to be exactly what Albert requires to meet his annual expenses. So, the magic numbers are a capital sum of twenty times one's annual expenses to be invested at an annual yield of at least 8% and 3% out of 8% annual yield is to be reinvested every year leaving only 5% out of 8% annual yield in any year to meet the annual expenses. Thus, financially freedom can be met if the magic numbers are observed. However, this is just a theory which may not work out in real life as the annual yield on one's investment may vary every year. If one can truly invest at a constant yield of at least 8% per annum, one is not very far away from the realities of financial freedom should one be able to accumulate a capital sum of twenty times one's annual expenses to be invested at such annual yield.

Of course, it does not take an intelligent mind to appreciate that if one requires less annual expenses to meet his lifestyle needs, one can become financially free faster. A person with an annual expenses of $12000 only needs a capital sum of SGD$240000 to become financially free in Singapore if the above magic numbers are observed. There again, is it possible to survive in Singapore with an annual expense of $12000 which works out to be approximately $1000 monthly expense? This is probably wishful thinking if not impossible to survive with such meagre monthly expense in a state of financial freedom. Who knows? Maybe there are already people who are financially free on a low living expense?

There are two choices.

Control money to reach financial freedom

or let money control oneself never to reach financial freedom.

Dividend reinvestment program (DRIP)

2012-05-13T23:48:00.000+08:00

Recently, one of my invested real estate investment trust (REIT) has announced a dividend reinvestment program (DRIP). This triggers the question as to whether DRIP is a good thing and should investors take up the DRIP. Before we delve into the advantages and disadvantages of such a program, we can look at what is a DRIP.

DRIP is a way for investors to receive the dividends from an invested company in the form of new shares or units (in the case of REITs). In a DRIP, an investor can choose to participate in it fully or partially. When an investor chooses to participate fully in DRIP, he is opting to receive fully all his cash dividends in the form of new shares/ units. When an investor chooses to participate partially in DRIP, he will elect to receive only part of the cash dividends in the form of new shares/ units while the remaining dividends is still disbursed to him in cash.

In calculating the number of shares or units an investor will receive, he will need to know the exercise price per share/ unit under the DRIP. For example, ABC company has announced a DRIP in which new shares are issued at the price of $1.95 per share. If an investor is receiving a cash dividend of $1950, he can opt to participate fully to receive approximately 1000 new shares in place of his cash dividend of $1950. Of course, he may also opt to receive partially his dividends in new shares and remaining dividends as cash. He may even choose not to participate in the DRIP in which case, he will still receive his dividends fully in the form of cash.

Advantages of a DRIP

1. It allows an investor to reinvest his dividends directly in a company as he is opting to receive new shares/ units in the company instead of cash dividends. By doing so, an investor can save on brokerage fees as he will need to pay brokerage fees should he buy new shares in the same company through a brokerage firm instead of participating in DRIP to receive new shares equivalent to the amount of his cash dividends.

2. A DRIP encourages investors to have a long term investment mindset towards a company. By giving investors a chance to participate in DRIP, some investors (especially those who choose to participate in DRIP) may stay invested with the company for longer term. This encourages price stability in the share price of a company when more investors are holding the shares of the company for longer term instead of actively trading the shares of the company.

3. A DRIP benefits the company as it can conserve its cash earnings to use it to further the growth and expansion of the company since some dividends are disbursed in the form of new shares instead of cash. Warren Buffet's Berkshire Hathaway Inc. has been known not to give out dividends to its investors but instead conserve its cash earnings to keep investing in growing and expanding its businesses. By doing so, it is able to expand its businesses and future earnings. In return, long term investors in Berkshire are rewarded by the capital gain from their shares which comes up to a substantial amount of returns over a few decades which will not be possible had Berkshire disbursed part of its earnings in dividends to its investors instead of using its earnings to grow and expand its businesses.

Disadvantages of a DRIP

1. A DRIP has its disadvantage as sometimes, an investor may not receive his amount of dividends fully for an equivalent amount of new shares/ units of the company. This is because any fractional new shares/ units under the DRIP are rounded down and disregarded. For example, the exercise price of a DRIP is $1.943 and an investor is opting to receive fully his dividends of $1950 in the form of new shares in a company. His amount of new shares equivalent to the amount of cash dividends of $1950 is approximately 1003.6 new shares. In this situation, he will only receive 1003 new shares instead of 1003.6 new shares as fractional shares are disregarded. However, this is only an insignificant amount as he only loses around $1.16 of cash dividends for that puny 0.6 fractional new share he lost.

2. Another disadvantage of DRIP is that an investor usually lands up with odd number of shares. In the above case, an investor opting fully for the DRIP will land himself with 1003 new shares. Assuming he has existing 11000 shares in the same company, he will now have 12003 shares after the DRIP. When he decides to exit fully his shareholding in the company in future, he will have difficulty selling the extra 3 shares on top of the 12000 shares. In order to do so, he will need to sell his odd number of shares through his brokerage firm on a different market catering to odd lot shares which will incur higher brokerage charges compared to selling the usual number of shares on the normal market.

3. The exercise price of a DRIP may not be attractively priced compared to current traded share price in open market and intrinsic value per share. If the existing shares of the company participating in a DRIP is traded at $2.00 per share in the open market and the exercise price of the DRIP is at $1.98 per share. As such, an investor will be better off with receiving the dividends in cash and wait until the traded share price is below $1.98 to buy new shares in the open market at a lower price than the exercise price of the DRIP. If the traded share price of this company should become lower for example at $1.93 per share in the open market, the investor may even save some money (after factoring in brokerage costs) if he purchases new shares in the open market instead of participating in the DRIP at a higher exercise price of $1.98 per share. Such swings in traded share price is not unusual within a short term period given the volatility in the stock market. Also, if the exercise price of the DRIP is higher than estimated intrinsic value per share determined by the investor, there is no margin of safety in participating in the DRIP as an investor will be receiving new shares through the DRIP which are not attractively priced. Thus, does one wait to buy at lower share price or participate in the DRIP? Let the investor decides for himself since the exercise price of the DRIP is not attractively priced.

Conclusion

In considering whether to take up a DRIP, one has to look beyond the advantages and disadvantages of a DRIP. As Benjamin Graham, the father of value investing puts it, "Investing is most prudent when it is most business-like". How an investor should approach DRIP is from assessing the business behind the listed company.

Questions to ask include:

1. Does this company have a competitive moat?

2. What is the future growth prospects of the company?

3. How is the management of the company? Are they trustworthy and capable?

4. How is the financial track record of the company? How are its performance in growing its revenue, managing its expenses, profit margins, cashflows, debt levels (is it precariously over leveraged) and short term/ long term liquidity?

As one can see, the focus is not whether a DRIP is good or bad for the company or its investors. A DRIP actually brings one back to investigating the fundamentals of the business behind the listed company. DRIP for a gem or DRIP for a rock. Let the investor decides whether the fundamentals of the business behind a company offering DRIP points to the company being a gem or a rock. As always, one should seek to purchase shares at undervalued or fair valuations. That includes reinvesting in new shares through DRIP only at fair valuations.

Water the right plants (participate in reinvesting in good companies through DRIP) that will grow to produce much better yield through time. A caveat to note that not all companies are even good to invest in, much more consider their DRIP.

Have you bought insurance for your shares?

2012-04-23T01:42:00.002+08:00

We insure ourselves for a lot of things in life from our home, our belongings, our car, our medical expenses to even our lives. Insurance is just a way to protect ourselves from the uncertainties in life. In an unexpected event, we are still able to carry on surviving through life in the case of all types of insurance coverage which allow a financial payout secured through an insurance company to tide through life crisis except in the event of death which already cost us our lives. In this case, our loved ones who are still around are able to carry on life based on the insurance payout to tide them over the crisis of losing a loved one (especially if the lost one is the breadwinner of the family).

In stock investment, one can consider buying insurance for his investment. By this, I do not mean literally buying insurance, but "buying insurance" in the sense of preparing for the wild swings of the volatile stock market. Stock investing is volatile in the short-term, but profitable in the long-term. To protect against the wild swings of the volatile stock market, one has to "buy insurance" by having an adequate amount of emergency fund and opportunity fund to capitalise on any wild swings in the stock market.

There is no hard and fast rule to how much emergency fund and opportunity fund one should hold on to in preparation for investment opportunities when the occasions arise. It depends on the investor. A conservative investor will hold more emergency fund and opportunity fund in proportion to the amount of his investments. An agressive investor will likely invest almost all of his available cash leaving little cash reserves each time to capitalise on any opportunities which may arise occasionally.

A general guide is to have an emergency fund which is equivalent to three to six months of expenses to tide through any emergency such as retrenchment from work or inability to work due to circumstances like disability, illness or sudden change in family situation (e.g. sudden death of a family member). Having both emergency and investment opportunity fund will mean that one has "bought insurance" for his stock investment. In the event of any emergency in the life of an investor, he need not liquidate his shares at a wrong time (especially in a down market) to raise fund to meet the emergency. When a down market is presented, an investor having opportunity fund will be able to invest upon such down market opportunity buying undervalued stocks and will not miss it and thus be subjected to the volatility of the stock market playing out on him.

Thus, an investor has to ensure he has "bought insurance for his investment" by setting aside an emergency fund and also an opportunity fund. I found out that there are approximately three to five profitable chances in any year based on compiled statistics of historical stock market behaviours to invest in stocks yielding good reasonable returns. The more times one invests in a year in excess of five times may not guarantee good profits. This means that an investor has to be very patient to observe the stock market every year to invest for only up to a maximum of five times in any year. The rest of the time in any year is spent observing for a good moment to invest.

This is pretty much like fishing, waiting for the fish to bite the bait. In this case, the bait is the amount of opportunity fund one has set aside while the fish is the valuable stock one is eyeing for to purchase at an undervalued or reasonably valued price in any year. There may be only one good opportunity to invest in any year to catch a stock at its undervalued or reasonably valued price. There may be a few more opportunities to catch the same stock at an undervalued or reasonably valued price in any year. However, there is no such thing as a great value every day for the same stock. Even if one is a trader, he also knows his boundaries to stick to his trading signals and trade only when opportunities arise.

Since there is so much uncertainty in the stock market due to the European debt crisis, slow recovery of the US economy and slow down in China's economy, one must be ready with opportunity fund which will be his insurance to protect against any potential swings due to the volatility of the stock market which is affected by a myraid of economic events worldwide. When a down market does arise, he will be able to exercise his insurance (opportunity fund) to buy up undervalued stocks. Even if such down market does not arise any time soon, the investor can sleep well every night knowing that he is insured and will be able to purchase into undervaled stocks with an adequate opportunity fund set aside whenever the down market arises.

The stock market will always continue to be volatile due to the different sentiments of many stock market investors. There will be highs as well as lows. With insurance (an opportunity fund) set aside, an investor just need to be a fisherman patiently waiting for his fishes (stocks) to bite the bait (to become undervalued) so that he can reap a harvest of fishes (buy into undervalued shares of companies). This opportunity will surely come a few times in a year. Just be patient to have an adequate opportunity fund ready to insure against such down markets and exercise this insurance (opportunity fund) to purchase undervalued shares without feeling the stress of having to face a down market while not being able to invest into undervalued shares.

Not having insurance creates uncertainty. However, it is also no good to be over insured. Cash on hand depreciates in value with time. Thus, one has to have an adequate amount of opportuntity fund but not in excess so that one is over insured and under invested. Cash can only grow in value while being invested. The value in holding cash is for emergency use, opportunity fund for investment or some personal immediate uses. Holding too much cash is not going to act as insurance but on the contrary is depreciating one's networth by the day.

Have you bought insurance today against the volatility of the stock market by having enough emergency fund and opportunity fund (to capitalise into investment opportunities when presented), but not in excess (being over insured and under invested)?

There will be "rainy days" (stock market lows) in the stock market in any year. Having enough insurance (adequate amount of emergency fund and opportunity fund) will allow one to capitalise on that few investment oppotunities (during stock market lows) in any year and to sleep well every night while waiting for that rare few investment opportunities to be presented.

Pricing strategy.

2012-03-09T19:00:00.004+08:00

For everyone, we have definitely encountered times when we need to sell anything, be it selling our products or services for a business, or selling our own personal items. How do we price the products, services or even our very own personal items we sell? I have always held the opinion that it is never good to compete to sell anything based on prices alone. Even if an item is a commodity which does not differentiate itself from another same commodity being sold by a competitor, one can still adopt a creative selling approach to make the item of commodity become unique in the eyes of the buyer. This involves creating added value to the buyer so that he will not be just buying the same item which he can easily buy elsewhere from another competitor. It does not take much thinking to appreciate that the same Coca Cola can drink can be sold at different prices at different venues. A can of coke sold off the shelf of a supermarket in Singapore costs approximately $0.70. The same coke sold off a vending machine costs approximately $1.20 while the price of this same coke sold in a restaurant costs approximately $2.80.

Why is there such a disparity in the prices of the same item, a can of coke? I consider this creative selling which involves creating added value. The same coke sold off vending machines bring convenience to the buyers as they can go to any nearby machine to buy a can of coke at anytime of the day including wee hours when everyone is sleeping when a particular buyer has a sudden craving for this soda. A restaurant offers a comfortable dinning environment to enjoy this can of coke. So, the price of coke is sold higher for the consumer not only to drink coke, but also to drink it at a very comfortable environment. This creation of unique added value makes the selling of coke becomes uniquely different commanding different selling prices. For the vending machine, it targets consumers who want the added value of convenience. For the restaurant, it targets consumers who wants the added value of comfort to enjoy this soda.

Well, do people still pay much higher prices for a can of coke sold off a vending machine or in a restaurant? Your guess is as much as mine. Yes. People do pay for higher prices. The difference is that coke sold in a restaurant only attracts a certain target consumer group, those going for added value of comfort while vending machines attract another group of consumers, those going for convenience. As to coke sold off the supermarket, it does attract peope who are price sensitive and do not need any added value to their purchase of the coke (placing their only buying consideration on price alone and nothing else that can move their hearts to pay more). Thus, by focusing on the creation of value even when selling the same item, higher selling prices can be commanded and the product or service can be sold to a relevant target group of consumers who see the added value they are paying more for.

There are 5 different ways by which most businesses priced their products namely:

1. Making wild guesses.

2. Following industry norm.

3. Clients dictate their prices.

4. Cost plus pricing.

5. Target return pricing.

1. Making wild guesses

This needs no explaining. The seller prices his products and services according to what he thinks buyers are willing to pay. There is no survey and research done. Neither is there any history to base the pricing on. The pricing is based on luck mentality. If the product can sell at this price, it sells. Otherwise, it will not.

2. Following industry norm

This way of pricing looks into what prices the other competitors are selling the same or comparable product or service. Usually, an average selling price in the middle is derived by considering the highest price and lowest price other competitors are selling comparable products or services. This works on the assumption that other competitors in the industry must be doing the right thing since they are able to sell their products and services.

However, assumptions may not always be a good thing. What is applicable for other competitors may not be applicable for oneself as their situation is uniquely different from each other as well as different from oneself. For example, a larger competitor may be able to sell their products or services at lower prices based on their economies of scale without eroding their profit margin. A weaker competitor may find it hard to follow suit with low pricing as this will mean a much lower profit margin or even making a loss resulting in the inability to sustain itself. In the long term, even if the weaker competitor is able to barely survive, there will be very slow growth (if any) as without profits, growth will slow down. Thus, a pricing which works for a competitor may not necessarily work for oneself.

3. Clients dictate their prices.

This way of pricing places priority in the clients to dictate what maximum prices they are willing to accept to buy one's products or services. This is done by running surveys, focus group discussions or causal talks with clients to know what maximum prices they are only willing to accept when buying one's products or services. It is good to always listen to the needs of one's clients. However, if one decides on the selling price solely on the clients' wish, it may mean lower profit margin thus resulting in unsustainability or lethargic growth in a business.

A business exists to serve the needs of its clients. However, also as important is the need to be profitable so as to continue in existence to serve the needs of its clients and even serve it better. If a business is not making profits, how can it grow and improve its products and services to continue serving its clients with better products and services. So, profitability of a business and its great meaning and purpose to serve through providing relevant products and services to clients go hand in hand. Greater value offering comes at higher prices. Higher prices fuel profitability to further improve value offering.

By not allowing clients to solely dictate the selling price, one is also training its clients not to focus on price alone but consider the value in the product and service offering of a business.

4. Cost plus pricing

This way of pricing considers the cost of producing a product or service, and the selling price is derived by adding a desired amount of return based on cost. This way of pricing has some inherent flaws. By using this way of pricing, one is not considering whether the clients can accept the selling price. Clients generally do not care about how much it cost to produce one's products or services and also the amount of desired return one requires when pricing the product or service. What they generally do care is whether they need or want the product or service and whether they want to pay or can afford to pay at a particular selling price.

In this way of pricing, one may also need to carefully consider the true cost of producing a product or service. Sometimes, it may suddenly require a large increase in cost to acquire a machine or more manpower cost and delivery cost to sell products or services to the clients. Thus, costs do fluctuate significantly sometimes. Also, there may be seasonal demand for one's products or services. Is a business going to sell at a much significant lower price when the cost of producing a product or service has gone down due to slower demand for some periods of the year? Can one really fix a suitable selling price based on cost plus way of pricing?

Furthermore, pricing of a particular product or service may influence sales of other different product lines or service lines in a business. If pricing a product A at a certain price results in more of the product sold and less of another product B being sold, the loss incurred on product B has to be amortized and accounted for as a cost added to product A. Thus, there will be changes to costs of individual product or service lines.

Also, there may be differential costs in selling the same product through different people or different means. For example, it may cost more to deliver the same product overseas than locally. It may also involve different costs to sell the same product by different salespersons.

Thus, this way of cost plus pricing is a difficult way to determine the selling price of a product or service as one will need to know the actual true cost of producing the product or service.

5. Target return

This way of pricing looks at a business and its prices as an investment. A target return on the capital invested in a venture is set. This is one's required return on investment. This way of pricing is more focused on profits, but it can also ignore the realities of the market similar to cost plus pricing, by focusing on unrealistic return on investment.

What is the purpose of pricing?

As one can see, no matter which way of pricing one chooses, the purpose of pricing is still to make profits for a business to ensure growth and sustainability. Even if one is taking a loss by lowering prices for example in giving discounts, it must still serve the purpose of taking a loss today in order to make a greater profit tomorrow.

Price skimming

One way of ensuring high pricing is to adopt a price skimming method. The objective of price skimming is to serve clients who are not price sensitive and are willing to pay higher prices for the exclusive value they can get from one's products or services. This is similar to the analogy of skimming off the top cream of the milk much like skimming off the top level of clients who are willing to pay higher prices for the exclusive value they get. This ensures high profit margins.

Sequential skimming

Another method related to price skimming is sequential skimming. For this method, clients who are willing to pay higher prices for premium value they get from a product or service is secured first. When demand for the product or service drops, the price of the product is lowered to increase demand for the product serving the next level of buyers. The price is again lowered when demand further drops after sometime thus attracting the next lower level of buyers. This method of sequential skimming is evidently seen in the sale of many electronics such as computers. When a new computer product is newly introduced in the market, it is priced at a premium attracting the first level of buyers who are not price sensitive but are focused on the immediate value they get from their purchase. When demand drops, the selling price is decreased to attract the next level of buyers and so on.

Penetration pricing

This method of pricing involve lowering prices below the competitors to quickly attract more clients thus seeking to increase market share. Penetration method works on the assumption that people are always attracted by lower prices. This method may be useful to increase market share quickly, but it can also become damaging to profit margins. Thus, this method is a short-lived method to penetrate one's market to gain market share and should be carefully used. In order to sustain long term growth and profitability, other methods of pricing such as skimming are better. One should not only consider the market share for his products or services, but more importantly the profits. For without profits, a business cannot sustain itself.

Conclusion

Pricing of product or service is an important part of a business. Purpose of pricing is to make profits without which a business can not sustain itself or see long term growth. There will always be people who are not price sensitive and willing to pay premium prices for premium value they can get from their purchase. This requires the business to adopt creative ways of offering premium value in their products or services in order to charge higher prices to attract their top level buyers. Sequential skimming is a method which can help to maximise the prices at each levels one can sell sequentially to different levels of buyers. Profits should be also considered in addition to gaining market share when using price penetration. For what good is there in gaining market share when a business is selling products or services at low prices which does not sustain profitability and results in causing long term irreparable damage and loss to the business.

Pricing is an important part of a business. The purpose of pricing is to make profits which results in long term growth and sustainability of a business.

How much do you think a particular real estate property should be worth?

2012-02-02T04:15:00.005+08:00

John and Jane were walking down a street when they chanced upon a signage in front of a residential property which the contents read, 'Property for sale at $700,000. Hurry! Best value for your money! Call xxx-xxxxx to view!' John exclaimed, "Wow. This property is up for sale. It sure does not look cheap at $700,000." Jane replied with skepticism, "Are you sure this price is not cheap? I think this price feels reasonable to me." At that instant, a passerby who saw both John and Jane in a bit of argument over the fair value of the property asked them what had happened. After knowing their argument over what the fair value of the property should be, he said, "Maybe we should find out more details from the seller of this property and do a bit of calculations to estimate the fair value of this property. This is at least better than trying to guess what the fair value of this property should be, isn't it?"

Many a time, we may have heard of comments on prices of real estate properties from different people. The perception of cheap or expensive for a price tagged to a particular property can be very subjective. In coming up with the valuation of a property, there are many different methods that can be used such as a sales comparison method, cost method, or profits method etc.

The sales comparison method seeks to derive the fair value of a property by comparing the property with the prices of other similar comparable properties that have been recently transacted in the market. The cost method is a method which seeks to arrive at a fair value for a property by estimating both the cost needed to build a similar comparable property to the property in question plus the market value of the land. The profits method seeks to arrive at a fair value for a property by considering the amount of business that can be carried out using the property thus providing certain amount of profit yield for the owner of the property. A discounted cash flow model can be used in the profits method to derive a fair value for the property.

I am not an expert in appraising a property. However, I will share in this post one of two ways I think are quite useful even for a layperson to derive a reasonable fair value for a property. By using some science over here in deriving the fair value of a property, hopefully one will avoid the same circumstance faced by John and Jane in the above scenario whereby the judgment of the fair value of a property is solely up to one's emotional gut feel. Therefore, the next time when one chances upon a property up for sale, one will not be making a rash emotional judgement on the fair value of a property but instead make a better judgement if not the best based on some science and numbers.

Before I delve into sharing the one out of two ways I learnt in deriving the fair value and profitability of a property transaction, there are some common simple ways to look at profitability of a property. Assuming a property is rented out, one can look at the annual rental returns to derive his return on investment or return on equity.

Example: A property has monthly rental income of $2000. The annual rental returns is $2000 X 12 = $24,000.

If the property was bought at purchase price of $600,000,

Return on investment
= (Annual rental returns / Purchase price) X 100%

= ($24,000 / $600,000) X 100%

= 4%

This property was bought with a downpayment of 20% of its sale price which is $120,000.

Return on equity
= (Annual rental returns / Downpayment) X 100%

= ($24,000 / $120,000) X 100%

= 20%

Notice that the return on equity is much higher than the return on investment. This is the magic about property investment which uses high leverage such that the investor earns a much higher returns on the money he has put in which is only the downpayment and other costs (which are not significant compared to the purchase price of the property). The small downpayment is the equity he owns in the property in order to reap a high profitability (his return on equity) while someone else (the tenant) is paying for his liabilities (the mortgage loan and maintaining expenses) on the property.

The long term effect of this is that the landlord eventually pays up the property with only his initial downpayment and other costs involved (which are not significant) while most if not all of the mortgage loan is paid by someone else (the tenant) for the landlord. A caveat here to note is that the investor must ensure he or she is financially able to have holding power on the property over a good number of years to continue to earn a high return on equity while possibly enjoying capital appreciation of the property as well. If property investment is done carefully, this is one of the best investment asset class which promises a high return on equity plus potential capital appreciation.

Now, let us look into the two scientific ways of assessing the fair value and profitability of a property investment, namely by looking at the Net Present Value (NPV) and Internal Rate of Return (IRR). However, I shall only focus on the first way in this post which is NPV.

Net Present Value (NPV)

Net present value (NPV) of a property is derived by the present value of the inflow from the property (rental income and other benefits) subtract the present value of the outflow from the property (all costs).

Any investment such as property investment is profitable if the NPV is positive. This means that the present value of all benefits outweighs the present value of all costs in owning the investment.

NPV used in assessing the profitability of a property purchase

An investor bought a condominium at $800,000 and paid a downpayment of 20% of its purchase price and after adding other costs such as stamp duty fees and legal fees his initial cost in buying the property comes up to $180,000.

The net positive cash flow is $5000 for the first year, $7000 for the second year, $7000 for the third year, $7000 for the fourth year and $7000 for the fifth year. The net cash flow per year is derived by the total annual rental income for the year subtract the total annual maintenance fee, total annual loan repayment and annual property tax.

The formula for NPV is somewhat similar to the formula for discounted cash flow (DCF) as NPV works on the principle of DCF.

CF = cash flow

n = number of year

r = required rate of return (in %)

The required rate of return by this investor is 8% (his expected rate of return when considering entering into this investment compared to other investments).

Thus, for this investor, his calculated NPV is as follows.

For CF0, it is a negative number of -$180,000 since the investor's initial cost is an outflow. The calculated NPV is -$153,902.88. From this negative value, we can see that holding a property for rental income for a few years still incur more outflow than inflow in present value as the initial sunk in cost of $180,000 is not a small sum. It takes more number of years to see profitability in NPV (NPV showing a positive value) especially after the mortgage loan is fully paid up and there is a significant increase in the cash flows thereafter.

In most cases, an investor seldom holds a property for very long term. He or she will try to sell the property for capital gain given an opportunity. That brings us to the discussion of what is a fair value that this same investor should sell his property at the end of 5 years.

NPV used in assessing the profitability and fair value of a property sale

Assuming his estimated mortgage loan balance outstanding after 5 years is $850,000. He decides to sell his property at the end of the 5th year. Two buyers are interested to buy his property. Buyer A quotes him $1,000,000 while buyer B quotes him $1,100,000.

When the investor decides to sell his property after 5 years, he will incur an agent fee (approximately 1% of selling price) and legal fees (approximately $2000). We will proceed to calculate his final cash flow at the 5th year (also known as the reversion value) when he sells his property.

Final cash flow at 5th year (reversion value)

= Selling price - Selling fees (include agent fees and legal fees) - Mortgage balance outstanding

For the investor, his reversion value for selling to buyer A

= $1,000,000 - $12,000 - $850,000

= $138,000

His reversion value for selling to buyer B

= $1,100,000 - $13000 - $850,000

= $237,000

Selling to buyer A, the investor's NPV is calculated as follows.

Selling to buyer B, the investor's NPV is calculated as follows.

In both cases, the investor's required annual rate of return is 8%. We can clearly see that if the investor sells to buyer A, his NPV is a negative value at -$59,982.40. This means the present value of all outflows is more than present value of all inflows. A negative NPV is thus not profitable for the investor.

On the other hand, if the investor sells to buyer B, his NPV is a positive value at +$7395.33. This means the present value of all inflows is more than present value of all outflows. A positive NPV is thus profitable for the investor.

Therefore, when presented with two different asking price of $1million and $1.1 million for this investor's property, he should sell only to buyer B at $1.1 million to make his transaction profitable. Though both selling prices are only a difference of $100,000, this difference will determine whether the investor will make a profitable or non-profitable transaction. We can see that the fair value for this property after doing calculations of its NPV should be more fairly priced at $1.1 million instead of $1 million when the investor decides to sell after holding his property for 5 years.

An emotional investor may just see that selling price of $1 million is already more than his initial purchase price of $800,000. However, it is only the astute investor after doing his calculations will know that selling at $1 million for this property is actually not profitable at all. A fair value will be $1.1 million instead considering the NPV of this investment. Emotions may lie to an investor but numbers show up the facts about an investment and its fair value. This is the science of successful investing.

PS: Please note that the example and figures quoted in my post are fictitious. The example quoted is not an actual property transaction. The learning point here is that an investor can carry out his own calculations based on details of his investment to determine the profitability and fair value of his property investment.

It is only fair to both parties in a transaction to know the fair value of the item transacted!

A must-have cash flow asset in any investor's portfolio!

2012-01-26T00:53:00.005+08:00

I believe this asset class is one of the best asset classes around if not the best to be owned by anyone. The asset class I am referring to is real estate property. I am not referring to real estate investment trusts (REITs) which is what I call the paper equivalent of owning real estate property as one only has minimal control over the physical properties under management by the REIT unless one is a major unitholder in the REIT. I am referring to one being the owner of real physical properties, having the full rights over the physical property.

There are three common major types of real estate properties one can own namely, residential, commercial and industrial properties. I am by no means an industry expert in properties. However, by my limited research so far, all three types of properties have their individual unique strengths and attributes. It really depends on what an investor is looking for, capital appreciation or cashflow from owning the property.

I shall not delve into the unique strengths and attributes of each of these types of properties in this post. However, I will like to impress upon the reader that real estate property is one of the best investment asset classes around to own. I call it a must have in any investor's portfolio. Real estate property may also form a large portion of an investor's porfolio since a real estate property is usually in the hundreds of thousands or even millions in the case of high-end properties. I am sharing this in the context of property valuations in Singapore. Private residential property such as condominiums are easily priced at $500,000 and above in a normal market. Gone were the days when one can buy private residential properties at below such a value. Commercial and industrial properties are also not cheap over here in Singapore with prices also in the range of hundreds of thousands to millions.

As such, a typical investor with no enormous cash reserves has to apply leverage when investing in real esate properties. It is the application of leverage that makes real estate properties very attractive as an investment class. What makes it further outstanding is that in Singapore, the leverage one can apply when investing in properties is one of the cheapest around. This is what I call cheap leverage applied onto a stable investment asset class.

A typical investor buying into residential real estate over here in Singapore needs to pay a downpayment of cash and/or CPF of 20% on the valuation of the private residential property such as a condominium. In additional to this, there are also other costs such as agent commision fee, stamp buyer fees and legal fees. After one factors in all of the costs and downpayment needed in buying a private property, the amount of capital needed to invest in a property is still not too high compared to its valuation. This provides a very favourable loan to value ratio. One can apply for a high amount of loan with a low initial capital commitment compared to the valuation of the property.

This makes real estate property a highly leveraged asset class for an investor. Furthermore, the interest rate for mortgage loans to buy properties is one of the lowest around compared to other types of loans in Singapore. This makes investing in properties a cheap highly leveraged asset class for investors. Properties tend to hold their values or increase in value over the long term (if the property in question is really a good buy). This further adds on to the attractiveness of real estate properties as an investment class as one can look at stable capital apppreciation over the long term (in many cases, capital appreciation in properties is known to beat inflation over the long term).

If an investor decides to rent out a property and the rentals collected are able to pay for the expenses in maintaining the property and even pay for the mortgage loan, the result of this is that another person (the tenant) is effectively paying the property for the investor. Once the property is fully paid for, the investor can sell the property at a profit (when the valuation of the property is higher than the initial purchase price) or continue to rent out the property for rental income which translates to recurring passive cash flow income which may be perpeptual (in the case of freehold properties).

As such, real estate properties can potentially provide a source of recurring passive income (once the property is fully paid for and the liabilities on the property is significantly reduced) for an investor's retirement period. I have personally known of people who have enjoyed and are still enjoying the recurring passive rental income stream from owning real esate properties. Of course, one can critique that this income stream is not totally passive as an owner of the property still needs to engage the tenant fulfiling his obligations to the tenant to manage the rental property. However, this property management work is not taxing at all compared to holding a full-time job. If a landlord chooses not to get directly involved in managing the property and tenant, he or she can engage a property management company at a cost which still makes the cash flow on the property attractive minus the headache of managing the property and tenant.

With prudent planning considering that one is able to buy and has holding power on a property through the ups and downs of the property market, not over commiting financially, one will be able to reap the rewards of a cheap and highly leveraged investment asset class which promises good cash flow. This is a must have cash flow asset that any investor should aspire to own in his portfolio. The important thing in any investment is to assess one's capability to buy and hold the investment asset while reaping the cash flow and financial reward, and only sell at a right time (when capital appreciation far outweighs the potential future cash flows or when another better investment asset comes along).

In all these, the caveat of buying undervalued or reasonably valued cash flow assets and selling over valued assets still holds even when investing in real estate property. Successful investing is simply a numbers game (a science) and also a sound judgement game (an art). It was never meant to be an emotional game (getting caught up with greed and fear). If the numbers are good after one has assessed the potential of the investment asset, one should own the asset.

PS: Please note that this post is just a very small time discussion on the topic of property investment. There are so much more things to know about the topic of property investment. I thought that real estate property is such a noteworthy and very important investment asset class that any investor must not miss in his investment portfolio.

PSS: Do note also that any information provided in this post is in the context of Singapore property market. I am also not to be held responsible for any misinformation in this post. One should always do his own research before investing in any asset classes. Prudence is the mark of a successful investor.

Real estate property, a must-have cash flow asset in any investor's portfolio!

Reflections on my investing journey so far - "It is still cash flow that triumphs".

2011-11-04T18:46:00.010+08:00

As I reflect on my past three years plus of investing in stocks and shares, I learnt many lessons, some slightly bitter ones and some are good ones. So far, I am glad to say that I have not made any realised losses from the stock market yet. In fact, I have made steady returns of approximately 13% per annum over the past 3 years plus of investing mainly through recurring cash flows from dividends received from my stocks investments and some gains through selling of shares (a lesser amount though compared to dividends received). This figure of returns may not be exceptionally significant, but it is already better than most other alternative forms of investments. Also, I have not made a single realised loss on my investments so far.

I have learnt through my humble experience in investing so far that it is better to have the mindset of building assets that return stable continuous cash flow than to invest for quick returns. Even if one is going for an accelerated way of investing by investing for appreciation in value of assets (be it paper assets like stocks and shares or physical assets like real estate properties), one must still own an increasing amount of assets through the years that provides recurring and increasing cash flow that can beat inflation over the years.

Getting positive cash flow through owning assets is really everything about successful investing. Appreciation in value of assets is an icing on the cake. Even after one sells off an asset that has appreciated in value and made a gain, he is still faced with the decision to reinvest his gains and original capital into another asset. If he does not reinvest his cash, then cash will depreciate in value over time. By not investing one's cash, one is getting poorer by the days.

Ultimately, I believe the distinction between rich and poor people is just in the mentality of how they view money. The rich becomes financially educated and invests to control or own assets that provide them recurring and increasing cash flow that fights inflation. Of course, any appreciation in value of the assets is also welcomed. The poor views investing as risky or is just ignorant of the merits of doing proper investments. The simple key to successful investing is just to continue learning how to invest and just do it and really learn from mistakes and successes whenever investment decisions are made.

The more learning and experience one gains through own research and learning from mentors, the better it becomes as one matures in his investing journey. As I have already expressed in an earlier post quite sometime ago, my view on successful investing has not changed now. Building up the amount of high quality assets one can have the most control (be it paper assets - this tends to have lesser control for the investor as shares are just meager part-ownership of an invested company unless one is a major shareholder, physical assets or business) over time and getting increasing recurring cash flow which beats inflation will allow one to reach financial freedom sometime in life. Cash flow received from assets is further plough back to reinvest in more quality assets which further increases cash flow. This is a virtuous cycle of increasing cash flow over time (by compounding), cash flow that further feeds more cash flow.

Patience and endurance to resist instant gratification in seeing immediate gains is important. Surprisingly, I learnt through these three years plus of investing that money goes to the one who is not greedy for it. The more one is not greedy for money, the more rational and composed one is when it comes to long term financial planning and constantly making the right investment decisions. It is all about the mindset of the investor. The success and failure of investing is not so much affected by the economy, but often it is the wrong emotions of greed and fear that causes the investor to make unwise investing decisions.

I will continue to look out first and foremost for quality assets (be it in paper or physical assets or business) to invest for good quality cash flow while secondly welcoming the idea of appreciation in value of invested assets. Building cash flow through owning and controlling more and more quality assets over time that beat inflation heads down is the crux of successful investing that will enable one to reach financial freedom. Better yet is that the quality assets one has owned can appreciate in value over time. This simple rule of successful investing has not changed through the ages. I believe it will not in future too.

Are you into building more and more positive cash flow (by owning and controlling more quality assets) or "building" more and more negative cash flow over time (by spending more than one's income, chalking up bad debts or making unwise investment not in cash flow producing assets but in investments that may lose their value in the end resulting in a loss)? If 'cash' thinks that it is really king, 'cash flow' will be laughing his heads off at 'cash'. Perhaps, the mindset of wanting cash flow is probably better than the mindset of wanting cash when it comes to successful investing?

Think of cash flow investing as installing more and more taps that can be opened to provide more and more cash inflows. The choice of the right taps to install is important so that the right taps (quality cash flow positive assets) can continually provide more and more cash inflows over a long period of time to build one's passive income.

Differentiate - For it does not pay to be a copycat!

2011-09-28T01:59:00.020+08:00

In the business world and our lives, there are so many different things happening around us constantly. Everyone of us is in one way or another trading our time, effort and knowledge for a living. Time, effort and knowledge can be seen as forms of products and services offered to help answer another's needs or problems. Businesses are providing products and services and getting paid by their customers for such provision. Employees are being paid by their employers for their services. There are so many businesses vying for market share for their products and services as well as job-seekers going around looking for potential employers to persuade them to consider employing their services in order to secure a living.

With so much competition between businesses, job-seekers and even employees on their jobs, what makes a winner stands out among the crowd. The magic element is "differentiation". There is no incentive in being a copycat, an exact replica of another. By being a copycat, an individual or business can only at best be as good as the original and nothing better. To be a copycat also means being a follower, one who has no leadership in pushing frontiers to always explore better ways of doing things and improving oneself. The only means to a copycat is to imitate another leader. The copycat may survive for a while by imitation, but since there is no real innovation and tenacity to constantly better oneself, the copycat will sooner or later cease to survive once it cannot catch up with being a copycat of the leader.

As such, the only means to keep improving oneself or even to survive in this competitive environment of business and life is to "differentiate". In businesses, differentiation means having a unique selling point, how the business can be seen as different from it's competitors. To be different just for the sake of being different does not work. What works in differentiation is to differentiate in ways that better serve the needs of a target niche market.

There is no such thing as a forever market leader. There is also no such thing as a perfect market leader that can always serve their niche market in all perfectness. There are always unanswered avenues for innovation and improvement of products and services to better answer the needs of a niche market. The business that fails to constantly differentiate in ways that better serve their niche market will eventually lose out to another business that is able to differentiate their products and services to better answer the needs of their niche market.

What are the ways a business can differentiate? There are five strategies of differentiation as follows:-

1. Differentiate by being the leader.

2. Differentiate by being the specialist.

3. Differentiate by pricing.

4. Differentiate by design.

5. Differentiate by polarity positioning.

Differentiate by being the leader

A business can differentiate by being a leader of it's niche market. This means being the first in the market to offer a new solution to an existing problem. This new solution is in the form of a new product/ service that will better solve an existing problem. By being a leader in one's niche market, the new solutions in the form of new products/ services will gain market share rapidly since these new products/ services can indeed better solve an existing problem or answer a need of the niche market better than other products/ services around.

An example of such differentiation by being the leader can be found in the health and wellness industry where chairs are no longer just for sitting, but have gone through innovation to include massage capabilities so one not only sits but sitting becomes relaxation and enjoyment for consumers of such massage chairs.

Another example of differentiation by being the leader is in Apple's invention of it's first Apple iphones to include the keypad within the screen of the phone so it becomes a touchscreen and some computer desktop capabilities are also merged into the small touchscreen. Thus, one can operate the smartphone as both a phone and computer but at so much smaller size and with the natural convenience of touch using fingers on touchscreens.

Differentiate by being the specialist

A business can also differentiate by being the specialist in it's niche market. The niche market always look out for the best specialist which is the best in solving an existing problem compared to other competitors around. Usually, this involves a company focusing on one point in it's product or service offering and working to become the best in the market in that critical selling point. This selling point may not necessarily be a unique one, but it is definitely the best selling point for the specialist.

For example, a transport company can differentiate by being a specialist in providing the fastest transport service around. Another transport company can focus by being a specialist in providing the most reliable transport service around, making sure it maintains a clean track record of no damage ever to any goods transported under it's service.

Differentiate by pricing

Another way a business can differentiate itself is by pricing of it's products or services. A business should try not to compete based on prices alone. Mere competition by price wars does more harm than good to the business profit margins. In order not to compete on prices, businesses must offer unique products and services of premium quality so as to charge higher premium prices on the unique products and services.

The niche market may not readily accept higher prices for premium products and services offered. Thus, a company must communicate clearly and carefully to justify the higher price that it's niche market is paying for an added premium value of the superior products and services that can better solve their existing problems.

Differentiate by design

Differentiating by design involves a company aligning the ways it work to it's brand image. A company can focus on a few major qualities that are congruent to it's brand image and make sure it keeps to delivering on the qualities.

For example, a pizza company wants to project a brand image of always being polite and understanding the needs of it's customers. It can train it's employees to greet it's customers with a certain style and manner that projects politeness. It can also train it's employees on particular ways to handle complaints from customers that still project politeness even in difficult situations. To understand the needs of it's customers, the pizza company can have a customer feedback system to receive feedback ratings and suggestions on ways the company can better it's pizza products and customer services.

Thus, a company that can constantly deliver on the promises and qualities of it's brand image will be able to differentiate itself by design.

Differentiate by polarity positioning

Differentiating by polarity positioning involves doing things differently from one's competitors to achieve the same desired solution to an existing problem for one's niche market.

For example, airline companies provide the same solution to their market which is to carry their customers (their passengers) safely from one destination to another within reasonable travelling time. However, airline companies do not deliver this solution in the same way. Singapore airlines pride itself on providing it's customers with luxurious and premium quality flight experience while budget airlines provide their customers with a low cost and simple but still reasonable air travel experience.

Thus, businesses can do things very differently from their competitors by different polarity positioning while achieving similar promise of solution to the niche market's problem.

Conclusion

To increase business profit margins and expand market share, businesses must differentiate themselves from their competitors. It is damaging to businesses serving the same niche market to be competiting on similar terms and prices.

I recall a biology topic of interest that also provides an analogy to survival by differentiation. It is the topic of natural selection. In the harsh living environment, individuals of the same species (e.g. we humans) are found to be not exactly the same with one another. This differences in the individuals allow some individuals of the species to still survive when the harsh environment changes. Such individuals are the fitter ones with desirable characteristics that are able to survive in the changed environment. Should the original members of the same species be exact copies of one another, a sudden change in the environment would have wipe out the entire species. Thus, we see the merit of being different in the correct ways (for the fitter individuals) according to the rules of the changed environment, working out to ensure survival of these members of the species.

Differentiation in the correct manner is not only desirable, but necessary for survival in the harsh environment of life and business. Differentiation is also about a business providing unique and better experiences for it's customers that they cannot find elsewhere from the competitors.

Be similarly crowded out and suffocate or be different from the crowd in better ways.

Differentiate.......do it or die.

Share consolidation/ Reverse stock split.

2011-09-12T16:05:00.008+08:00

Recently one of my invested Real Estate Investment Trust (REIT) announced an intended unit consolidation exercise. This REIT is proposing that every five of it's existing units to be consolidated into one consolidated unit. For example, this means that an investor who has 5000 units of this REIT currently will see his number of units at the end of this exercise reduced to 1000 units. This is the basic idea of the term consolidation.

Common misconceptions regarding share/ unit consolidation

There are some common misconceptions to a share or unit consolidation (or otherwise known as a reverse stock split). Common misconceptions include the following:-

1. The investor will see a dilution of his holdings after the share/ unit consolidation.

2. The net asset value of the invested company will decrease after the share/ unit consolidation.

Share/ unit consolidation does not reduce the percentage interest of the investor in the invested company. There is no dilution to his holdings after the share/ unit consolidation. Let me illustrate with an example. Imagine there are four investors who intend to share 20 equal slices of a cake. Each investor is entitled to receive 5 slices of the cake (each investor gets 25% of the whole cake). Just before the cake is cut into 20 slices one of the investors suggests that it is too much of a hassle to cut the cake into 20 slices. Thus, all the investors together agree to do a cake slice consolidation of 5 slices to become 1 slice. Thus, each investor will only get 1 slice of the cake. This means the cake will now be cut into 4 equal slices instead of 20 equal slices. Each investor now gets 1 slice which is still 25% of the cake, just that the one slice has become a bigger slice by 5 times (since 5 smaller slices get consolidated into 1 big slice).

Also, in doing the cake cutting with consolidation of the cake slices, the total size of the cake has not dwindled or expanded. It is still the same old cake, just that it is divided into 4 equal bigger slices instead of 20 smaller slices to be distributed equally to each investor. Thus, the net asset value of a company remained unchanged after a share/ unit consolidation (compare this with the example of the total size of the cake which has not changed since no extra materials has been put into the cake to make it bigger nor any part of the cake taken away before dividing the cake for the four investors).

Reasons for share/ unit consolidation by a company/ investment trust

If a share/ unit consolidation has no material effect on the company and it's investors, then why does a company do share/ unit consolidation? Is it justifiable for such an exercise?

Any company can do a share consolidation or otherwise known as reverse stock split for various reasons. One of the reasons is to increase the share/ unit price of the company/ investment trust. Some stock exchanges do not permit stock price to be traded below a certain price, so a company that has too low a stock price has to do share/ unit consolidation in order to continue to be listed on the stock exchange. For example, a company share which is currently traded at $1/ share will see it's share price increase to approximately $5/ share after a 5-for-1 share consolidation. The total number of outstanding shares in the company will decrease by approximately 5 times since every 5 shares is consolidated into 1 share (eg. total outstanding shares of 5 million shares will be reduced to 1 million shares).

Another reason why companies do stock/ unit consolidation is to attract instituition investors. Institution investors mainly invest in companies with higher traded stock price (as such companies are "seen to be stable blue chips"). As such, there is more analyst coverage and institutional interest in such higher traded stock price companies (if one assumes higher traded share/ unit price equates to a blue-chip status). Thus, some companies can do share/ unit consolidation to increase their share/ unit price so as to gain institutional interest and analyst coverage. This is what I call, "to put on a premium branded suit on a man" so as to let the man look more attractive and gain higher prestige. However, the man is still the same man with same abilities and personality. Nothing much has changed except that he has donned a good looking suit.

Conclusion

In conclusion, when companies/ investment trusts do share/ unit consolidation, there is no material impact on their investors. There is no dilution of investor holdings in the company nor any change in the net asset value of the company after the share/ unit consolidation.

A share/ unit consolidation may be carried out by companies to gain institutional interest and analyst coverage. However, the investor must be careful to see that the fundamentals of the company has not changed for the better after the share/ unit consolidation (if one sees a share/ unit consolidation like a man who dons a good looking suit to make himself more attractive, but he is still the same person and has not necessarily become better in his personality and abilities). In such situations, I will still adopt a cautious attitude towards the company to continue to see that they do the right things to constantly improve their business as such share/ unit consolidation exercise may be just a "one-time putting on make-up" event.

"Excuse me sir, how will you like your cake to be cut?

20 equal small slices or 4 equal bigger slices?

We do not add extra materials or take away any part of the cake.

The cake is still the same total size no matter how you want it to be cut."

I BELIEVE.

2011-08-31T02:48:00.008+08:00

I read this book "Millionaire Upgrade" by Richard Parkes Cordock recently which revealed the important attributes that self-made millionaires or successful entreprenuers possess. These attributes are depicted by the book as eight important principles for anyone who aspires towards being successful in life and business.

The eight important principles are listed in an acronym fashion namely, I BELIEVE.

I = I believe in myself.

B = Be passionate and want it.

E = Extend your comfort zone.

L = Lies and luck don't work.

I = Install goals.

E = Enjoy hard work.

V = Very, very persistent.

E = Expect failure.

I = I believe in myself

The first "I" sets the stage for these principles of success to work. In order to be successful, one must believe that he can become successful. This positive self-belief in making things work out is not based on an arrogant faith in oneself being the smartest in knowing everything and how to achieve success in having pride in one's way of doing things which always is seen to be superior than others.

This positive self-belief is instead a consistent belief in oneself that he can persevere through all odds and challenges, and keep on trying one's best without giving up until he succeeds in what he seeks to achieve. This is an entreprenuerial mindset, one that has great endurance and tenacity to strive towards the end-goal without giving up despite disappointments and failures along the way.

Easy said than done. That is why not many people pursue the tough route of entreprenuership which puts the hardest test to one's life in making tough decisions and actions, and accepting the many failures and sometimes small successes before seeing the final great success of one's work. I see entreprenuership as the toughest examination of all the many examinations one takes in his student and even corporate years. To graduate as a successful entreprenuer, he will have to face the failures of many papers in this examination and learn from each failure in order to proceed until the end of the whole series of examination to become a successful entreprenuer both in maturity of knowledge and spirit of enterprise.

B = Be passionate and want it

To be a successful entreprenuer, one has to be 100% passionate in pursuing a great entreprenuerial purpose. A successful entreprenuer is passionate in living out his life in providing a meaningful product or service to value add in other people's life. His great entreprenuerial passion is in always innovating better ways to answer people's problems and make life better for people he is serving (in the provision of products or services). Pursuit of money through going an entreprenuerial route is not a strong motivator. Passion in doing what one enjoys that will bring about benefits to others he serve is an enduring motivator.

I see this similarity of the principle of passion with the ideas from the book "From Good to Great" by Jim Collins. Great organisations have great culture of passion in all its people in serving a great meaningful purpose. They continue to be great as they have passion in living out and serving their great meaningful purpose, the purpose for their existence.

As such, there is no point in doing something great and ambitious when one has no belief and passion in what one is doing. Find one's passion in life and become great in serving others through this meaningful purpose with an entreprenuerial heart.

E = Extend your comfort zone

Humans are creatures of habits of comfort. We have this tendency to keep repeating the same familiar habits that bring comfort to oneself. A successful entreprenuer needs to constantly extend beyond his comfort zone. It is through experiencing new things each day that one constantly learns. A baby who wants to walk the way adults walk has to extend beyond his comfort zone by actually trying to walk. He will never learn walking if he insists on his comfort zone keeping to familiar habits of doing a baby crawl.

To extend beyond comfort zone means conquering over one's fears and self-doubts. Everyone has fears of trying something new. It is the successful entreprenuer who is able to master courage to confront his fears head on and push boundaries to take on the new challenge and learn from it. Many great entreprenuers like Thomas Edison (in the constant invention of new things such as electric light bulbs), Henry Ford (in making available widely the automobiles to the masses) and the United State's project in puting the first man on the moon are examples of individuals and nations extending beyond their comfort zone not knowing whether what they aim to achieve will be successful or not. You never know until you try your very best.

L = Lies and luck don't work

If one thinks great entreprenuers are lucky chaps who got their way because they are simply born lucky, one will be extremely surprised. A successful entreprenuer does not rely on luck. What an onlooker views as luck is a duration of preparation which consumates with a great opportunity by the willingness and passion of the successful entreprenuer to pursue the opportunity that is presented. Tiger Woods, the world championship golfer did not got his lucky break all of a sudden to become world champion. It is through many years of preparation in golf training and taking part in many competitions that he manages to be known eventually as world champion. Thus, luck is the crossroads of preparation and opportunity.

Lies also has no place in a successful entreprenuer's belief. A successful entreprenuer does not hope for things to happen. He does not lie to himself and gives excuses that things will happen the way he hopes without taking any actions. Instead, he takes purposeful actions to make things happen the way he wants. Sometimes, things will not happen the way he wants after taking actions. However, he will still persevere on and keep trying different ways to reach his goals.

I = Install goals

To become successful, one needs to have goals and works towards them. Some have big goals. Some have small goals. Some have noble goals while others have more trivial goals. No matter what, it is important to constantly remind oneself of the goals one has passion in pursuing.

One can break down his goal into small steps and achieve one step at a time towards fulfiling the final goal. A successful person install goals and has clarity on what goals he wants to achieve in life. He is always taking actions to strain towards his goal in steps. A goal is thus fulfiling a dream with a disciplined deadline.

E = Enjoy hard work

A successful entreprenuer enjoys hard work. His work is not work to him but doing something he is passionate and believes in. As such, he enjoys what he is doing and does not mind going the extra mile to make sacrifices for what he is doing. Many a times, we have heard of great entreprenuers who put in many long hours of sacrifice into building up their business. For an onlooker, we may think such entreprenuers are overworked. However, to these successful entreprenuers, they just simply enjoy their hard work as they are working on their passion in life to serve a great meaningful purpose.

It is important to find one's true passion in life and then enjoy working hard at it until one reaches success in his goals (founded upon his passion). I read up elsewhere that successful people put in at least 10,000 hours of consistent hard work at learning and practising a particular trade in order to become an expert in the trade. This translates to approximately 3 hours every day of consistent learning and practice for 10 years to reach expertise in a trade. One really needs passion in a trade to enjoy this level of consistent hard work!

V = Very, very persistent

Successful people which includes successful entreprenuers are very, very persistent individuals. Their passion in pursuing their goals is so strong that they will not give up until they reach their goals. They will not take "no' for an answer, but will find means and ways to reach their goals. They are passion driven people who will do what it takes (personal sacrifices of time, effort and confronting their fears, failures and disappointments) to reach their goals.

One great inventor and entreprenuer who displays such great persistence is Thomas Alva Edison who despite failing many times in his many attempts for every new invention, never gives up and continues trying until he successfully invented every new invention. One of the products of his extreme persistence is his greatest invention, the electric light bulb which has lighted up the world since his time. Had he given up easily, the world may not see an electric light bulb today (unless another inventor of great persistence comes along somewhere in ages past to discover an electric light bulb).

E = Expect failure

All successful people including successful entreprenuers have failed many times. Such people know that one cannot win all the time. Failures are part and parcel of the learning journey towards success. It is in failing that one can learn from his mistakes and better oneself. The more failures one make, the more opportunities of learning and growing in wisdom and judgement. A successful learned man has gone through a robust experience of learning from many failures. As such, he constantly learns from mistakes and do not commit his mistakes again while finding better improved ways to do things.

It is the ones who are afraid to fail that never extend beyond their comfort zone to become better at their trade. Failure is a great teacher. Learn to expect failure. But, do not forget to learn well from this great teacher who is "failure" so as to constantly grow to become better after each failure.

A magic ingredient that binds all 8 principles

In conclusion, I will also like to share from this book that there is an essential ingredient for success apart from these eight principles. This magic ingredient that binds all the above eight principles is teamwork. It is not enough for one person alone to embrace all these eight princples to have success. Every successful entreprenuer knows he cannot achieve success on his own. He needs a team to work together with him pursuing the same passion and belief.

In a team, there is synergy and everyone can leverage on one anothers' expertise, time, effort, capital and all other shared resources for a common meaningful purpose they are serving. A successful entreprenuer surrounds himself with successful people who can work together with him with common passion and belief. He can also learn from other people in a team as everyone has their unique strengths, areas of expertise and even weaknesses.

It is not an easy route to success, "Do I BELIEVE?"

So you want to retire in Singapore?

2011-08-25T12:39:00.006+08:00

As I was going through my daily activities recently, the thought of retirement came through my mind. Do not get me wrong. I am not thinking of retiring anytime soon. Even if I do reach financial freedom before age 65, I will still find work to do, meaningful work especially. This is because I believe one should contribute his time to meaningful activities (providing a product or service) to help others since he is financially free with available time. Even if such work does not receive remuneration, as long as it is serving a meaningful purpose, I will still work for a meaningful cause.

Financial freedom is a blessing received and not to be taken for granted. I believe one who is in this special status of life should start living for others to commit his freed up time (since he is no longer financially burdened and need to restrict his time to working for a paid salary) to help others in need (in whichever meaningful ways).

Leaving financial freedom aside (which not many people eventually reach due to one reason or another), the more important issue of concern is retirement planning. Most people will live long enough to reach their retirement age. For Singaporeans, our retirement age is seen to be age 65 (at least by our government since the official age to receive our Central Provident Fund, CPF monies is at age 65). Assuming as a benchmark many people do work until age 65 and thereafter retire from work, how much does it cost to retire in Singapore?

I did an estimation of the cost of retirement in Singapore. I was shocked by my finding. This made me realise that it is difficult for many people to retire in Singapore, not to mention retire comfortably.

I provide a few case scenarios as follows:-

For a Singaporean aged 20 currently

Depending on individual's needs, let's assume an average comfortable living expense for an individual is around $2000 per month currently. When the individual reaches age 65, he will need around $7563.19 per month in year 2056 upon his retirement to continue living at his same living standards as of today. This is assuming an annual inflation rate of 3% over a period of 45 years until his retirement.

He will continue to live another 20 years of retirement (assuming the average lifespan is around 85 years). Assuming the same annual inflation rate of 3% over his retirement period, his total retirement funds needed is approximately $2,438,708.88. A $2.4 million sum need for retirement! What a staggering amount!

For a Singaporean aged 30 currently

Assuming the same comfortable living expense of $2000 per month currently, the individual will need around $5627.72 per month upon his retirement at age 65 (assuming an annual inflation rate of 3% over 35 years until retirement) for living expense to maintain similar living standards.

Over his retirement period of 20 years, his total retirement funds needed is approximately $1,814,627.21 (assuming an annual inflation rate of 3% over his retirement period). Ok. This is slightly better compared to the younger folk mentioned earlier who needs more in total retirement funds. However, a $1.8 million sum is not a small sum either.

For a Singaporean aged 40 currently

Assuming the same comfortable living expense of $2000 per month currently, the individual will need around $4187.55 per month upon his retirement at age 65 (assuming an annual inflation rate of 3% over 25 years until retirement) for living expense to maintain similar living standards.

Over his retirement period of 20 years, his total retirement funds needed is approximately $1,350,252.36 (assuming an annual inflation rate of 3% over his retirement period). This $1.3 million sum is not a small sum also for a slightly older folk currently to retire at.

Conclusion

As we can see, the older the Singaporean is currently, the lesser the total amount of retirement funds needed for his retirement. However, even at age 40 currently, the total retirement funds (approximately $1.3 million) needed to set aside is by no means a small sum to be overlooked.

I leave the reader to draw your own conclusion whether it is an easy feat to retire in Singapore or not. Are we prepared for the better or worst to come upon our retirement days? It is no wonder why our government keep increasing the retirement age (now already standing at age 65) and encourage Singaporeans to continue working as long as they are able to till they die. This leaves one thinking whether this is just a passing statement for the government to say encouraging older workers to stay active in their golden years by working, or that the harsh realities of retirement living dictates one's neccesity to keep on working until one drops dead.

Downgrade one's living standards during retirement days with whatever limited savings left? "Continue working" during "retirement days" to maintain current living standards or just to meet basic living needs? Be not financially burdened during retirement days by saving up and investing early during younger days? One needs to consider carefully his choice now as the consequence of his choice will unfold definitely in time to come.

Assumptions in my estimation

Please note the following assumptions in my estimation of the total retirement funds needed.

1. An average annual inflation rate of 3% at least over the next 65 years.

2. An average monthly living expense of $2000 currently for decent living standards.
3. Retirement age of Singaporeans at 65 years.
4. Average lifespan of Singaporeans at 85 years.

Level 5 leadership: A necessity for organisations to go from good to great.

2011-08-20T01:56:00.008+08:00

We have examined according to Jim Collins and his research team what the good qualities that good to great organisations possess, as well as the poor qualities that organisations on decline possess.

A large part of the success or failure in any organisation depends on it's leadership. It is necessary according to Jim Collins and his team's research findings that any organisation that aspires towards lasting greatness have level 5 leadership at their helm.

What exactly makes a level 5 leader?

There are 5 levels of leadership, namely:

Level 1: Highly Capable Individual.

Level 2: Contributing Team Member.

Level 3: Competent Manager.

Level 4: Effective Leader.

Level 5: Level 5 Executive.

Level 1: Highly Capable Individual

A level 1 leader is a highly capable individual who makes effective contributions at work through own personal knowledge, talents and skills. Such individual also possesses good working attitude and habits. However, the amount of contribution is only limited at an individual level.

Level 2: Contributing Team Member

A level 2 leader is an effective contributing team member. Such leaders are able to work effectively with other people in a group setting to achieve group objectives. As such, the level of contribution is higher at a group level.

Level 3: Competent Manager

A level 3 leader is one who is a competent manager. He is able to effectively plan and organise people and resources in the achieving of work objectives. His level of contribution is thus higher as he is not only a contributing team member, he is also the team leader of his team.

Level 4: Effective Leader

A level 4 leader is an effective leader. He not only fulfils the ability to lead his people and use resources to achieve work objectives and tasks. On top of that, he is able to drive and excite his team towards a clear vision. When directing his team towards a strong vision, he is also able to constantly stimulate his team towards giving their best to high performance standards. Such a leader contributes at even higher level in having a clear vision and taking his team towards fulfiling this strong meaningful vision while executing at high performance standards.

Level 5: Level 5 Executive

A level 5 leader is one who possesses a strong professional will in building his team of people and organisation towards lasting greatness. His ambition is not small but is great beyond measure. He aspires for his organsiation to be the best in the world that they can be and to have enduring greatness through time. Such great leaders are humble, for their ambition is never for personal interests or gains but only for his people and organisation to become the best they can be at serving their great meaningful purpose.

A level 5 leader is one who thus brings out the very best in his people and organisation in fulfiling their great purpose that the organisation is serving. He is a builder who builds lasting greatness into his people and his organisation. He builds greatness not for himself, but for his organisation to continue through time to be great and even better at serving their great purpose, the very purpose for the organisation's existence. His contributions to his organisation will carry on through time (even for many generations of leaders after him) even as he is gone.

Conclusion

An individual can proceed through the 5 levels of leadership to become a level 5 leader of greatness. This progress may not necessarily be through each level in sequence. A level 5 leader will possess all the capabilities of the other lower levels of leadership. In addition to these capabilities, he also possesses the special characteristics of greatness evident of a level 5 leader.

From Good to Great.

2011-08-18T03:08:00.006+08:00

If "even the mighty can fall", how do organisations ensure they tread carefully each step to go from being good to great and maintain their greatness to last. According to Jim Collins in his team's research findings in the books "Good to Great" and "Built to Last", there are 4 stages to transit from being good to great and to continue in greatness.

Stage 1: Disciplined people.

Stage 2: Disciplined thought.

Stage 3: Disciplined action.

Stage 4: Building greatness to last.

Stage 1: Disciplined people

Great lasting organisations have continual succession of level 5 leadership to carry on guiding their people and organisation towards greatness. Level 5 leaders are not commonly found (looking at how few the number of great organisations that have truly stand the test of time). Level 5 leaders are highly ambitious, but not for themselves. They are ambitious in championing the mission and purpose of their organisation. They will do whatever it takes to live out the mission and purpose of their organisation and ensures others in their organisation do likewise. Such level 5 leaders are humble but possess an exceptionally strong will to ensure their organisation work their best to live out their mission and purpose they are serving. Such level 5 leaders in their humility, look not inwardly to themselves for personal gains, but instead look outwards to build the best out of their people and organisation.

Great lasting organisations ensure they have the right people in their organisation (people who live out their organisational values, mission and purpose). They focus first and foremost on recruiting the right people to their key seats before deciding what these right people should do. The right people in key positions will naturally work together to ensure they take their organisation in the direction of fulfiling their mission and purpose. The wrong people in the organisation who do not live out the values, mission and purpose are promptly taken off the organisation.

Stage 2: Disciplined thought

Great lasting organisations do not avoid any confrontations of their problems and difficulties. They will do whatever they can to deal with and find solutions to their most brutal problems, mistakes and difficulties they face.

Such organisations also stick to the "hedgehog concept". The hedgehog concept embodies three principles:-

1. Continue to do what one can be the best in the world at doing (and keep improving in doing it).

2. Continue to do what one is deeply passionate about.

3. Continue to do what best drives one's economic or resource engine.

Stage 3: Disciplined action

Great lasting organisations have disciplined people. Such organisations enjoy a culture of freedom as their disciplined people work within a framework of responsibilities. Disciplined people take on responsibilities instead of jobs.

Such organisations function as though they are pushing steadily onto a giant flywheel, making turns upon turns, building up the momentum of the flywheel until they see a breakthrough. They are not hasty in trying to make quick breakthroughs with some grandiose program or actions. They understand the need to carefully build up their organisation towards greatness.

Stage 4: Building greatness to last

Great lasting organisations are built through many generations of level 5 leaders in succession. Level 5 leaders over many generations have built into their organisation mechanisms that stimulate progress. The success of the organisation does not depend solely upon the charisma of any one single leader or great idea.

Such organisations are able to continue in existence as they remain in living out their core values, mission and purpose which stand the test of time. However, they are also able to make significant progress by constantly adapting to the changing world in their operating strategies and cultural practices.

Conclusion

Building a great lasting organisation requires discipline, humility and a strong professional will of it's people to live out a set of timeless core values to commit to greatness in fulfilling meaningful purpose(s) in it's service.

Disciplined people. Disciplined thought. Disciplined action. Building greatness to last.

How even the mighty can fall!

2011-08-16T03:54:00.012+08:00

I like the series of books written by Jim Collins, "Built to Last", "From Good to Great" and "How the Mighty Fall". This series of books has it's content based on solid extensive research of examples of companies that succeed and fall. It gives a good insight into how some companies can become great and long lasting well known names, while others go into oblivion.

In this book, "How the Mighty Fall", I am impressed again by how Jim shared about their team's research findings of how every company, whether small or large enterprises can suffer the fate of becoming obselete and non-existent if they are not careful about continuing to be commited to being great.

The fall of any company, small and great alike according to Jim Collins seems to go through five stages (though some companies may not encounter all of 5 stages before capitulation to death), namely:-

Stage 1: Hubris Born of Success.

Stage 2: Undisciplined Pursuit of More.

Stage 3: Denial of Risk and Peril.

Stage 4: Grasping for Salvation.

Stage 5: Capitulation to Irrelevance or Death.

Stage 1 (Hubris Born of Success)

A search of the word 'Hubris' from Wikipedia comes up with the following meaning, " extreme haughtiness, pride or arrogance. Hubris often indicates a loss of contact with reality and an overestimation of one's own competence or capabilities, especially when the person exhibiting it is in a position of power."

These are various symptoms of stage 1 (Hubris Born of Success) in any organisations. Organisations may not display all of the symptoms, but many of them may be found in this early stage 1 of decline. Symptoms include people in an organisation taking success in their organisation for granted, believing that success in their organisation will continue indefinitely, no matter what they do or not do.

Leaders in an organisation become distracted from constantly strengthening and improving upon the core business that the organisation is already strong in doing. Leaders get distracted by pursuing new adventures, opportunities or being too absorbed in thinking about non-essential threats to their organisation.

The people in the organisation may also tend towards the "what and how" their success came about instead of cherishing "why" they got their success. People lose focus on their core values, mission and purpose of their organisation that got them successful in the first place and instead just base their success on their ability to carry out specific things or tasks in their organisation.

There is also a loss of learning culture in such organisations in stage 1 of decline. Since understanding of success is now based on what things and tasks to carry out, there is no longer any growth in pursuing learning. The organisation can only maintain status quo, and be at most as good as when their learning last stopped. Keep in mind that there is no such thing as 100% complete knowledge. The World contains a vast amount of knowledge beyond measure. The only successful individual or organisation is one that is constantly learning new things and value adding to themselves and others they serve.

Furthermore, such organisation in stage 1 of decline thinks highly of themselves, that they owe their success solely to the superior qualities of their organisation and leadership, instead of adopting humility and acknowledging that their success may have also arised from good circumstances and turn of events.

Stage 2 (Undisciplined Pursuit of More)

Organisations that proceed to stage 2 of decline confuse growth with becoming great. Such organisations in a bid to become great overstretch their people, systems and operations beyond what they can bear. Often, the dramatic actions such organisations carry out do not fit into their core values and do not enhance their core business.

Such organisations also lose the right people in important positions that ensures the success of the organisation. When pursuing undisciplined growth, organisations may also not be able to fill up enough right people into important positions as they grow and expand.

Such organisations in pursuit of undisciplined growth, may also respond to increasing cost of operations by increasing their prices of products or services to maintain profit margin instead of increasing their discipline at questioning carefully whether their growth is good growth or bad growth.

There is also an increase in bureaucracy in such organisations marked by rules governing actions, instead of maintaining a culture of freedom of expression fueled by strong cherished responsibility of every individual in the organisation, seeing that they do their best to be responsible for their work rather than seeing their work only as a 'job' they have no choice but to complete.

Furthermore, such organisations also face poor succession of leadership. There is no excellent succession plan in mind, no grooming of talented individuals within the organisation who live out the core values and purpose of the organisation for taking over the helm of the organisation.

People in organisations facing stage 2 decline may also look to their own personal interests more than the organisational interests. People pursue personal fame, popularity and power in the organisation more than investing their time in building up their organisation towards greatness for the long term.

Stage 3 (Denial of Risk and Peril)

In organisations facing the next stage of decline, there is a tendency to ignore the negative warnings (in the form of any negative data) that surface within the organisation. Leaders tend to also highlight every positive results to receive praises and publicity while ignoring or discounting any potential negative warnings in their organisation.

Leaders also tend to pursue big ambitious goals that are not founded on good analysis and past experiences. When presented with vague data that do not support well the pursuit of an ambitious goal or decision, leaders choose to ignore the potential significant downside while taking an overly optimsitic view of their decision which is not founded on good thought and analysis.

There is also a tendency towards a dictatorial style of leadership for organisations in stage 3 of decline. There is no evidence of much healthy debate or discussions when making decisions. People become mere followers of one or two leaders, and there is no generation of much ideas and opinions to ensure the best ideas and opinions can benefit the organisation.

Leaders in such organisations also push failures and mistakes to being caused by external factors and other people. They do not take any blame for their poor leadership.

When organisations are faced with stage 3 decline, they do not confront their problems and external conditions face on. Instead, people in such organisations are entangled in politics while their organisation keep reorganising in a bid to deal with their problems.

Furthermore, leaders in such organisations also face much detachment from their people in the organisation. They may get caught up with their executive status (good bonuses and nice offices) more than cherishing their commitment and responsibility to build their people and organisation.

Stage 4 (Grasping for Salvation)

Organisations in stage 4 of decline keep trying out different strategies and programs or acqusitions in a bid to get themselves back on progress. The leaders indulge in ways to motivate their organisation with buzzwords or taglines. However, they do not have a solid recovery long term plan in mind. So, there is inconsistency in that their strategies for salvation keep on changing in a series of highly-sought after silver bullets.

Often, such organisations employ an outside leader (CEO) as a saviour who is charismatic in a bid to help the organisation turn around.

The people in such organisations often display habits of panic and uncertainty instead of discipline and a calm resolve to support their organisation to make a turn around.

Leaders refuse to acknowledge their current underperformance. Instead, they try to sell their people the vision of a bright future admist the difficult times that the organisation is currently facing that may potentially lead to their permanent downfall.

There may be some respite when the series of random silver bullets are carried out in a bid to save the organisation, but these positive changes are not lasting. There is no real build up of recovery momentum in the organisation.

When an organisation has reached this stage of decline, the people in the organisation have lost their cherished core values in the organisation. They no longer remember and understand what is the values, mission and purpose of their organisation, why their organisation exist in the first place.

In a bid to save such organisations by administering random inconsistent strategies and programs, together with organisational restructurings, with each strategy being carried out, the resources (financial and manpower etc.) of the organisation are further drained out. This accelerates the decline of the organisation.

Stage 5 (Capitulation to Irrelevance or Death)

As organisations reach stage 5 of decline, the certainty of death of an organisation is pronounced. Organisations in this stage of decline keep deteriorating as cash continues to tighten and hope disappears.

Such organisations should prepare for their death by doing what is best for their employees and shareholders with whatever limited resources left. This may involve returning whatever left over cash as compensations to their employees and shareholders after settling all debts. Some organisations facing impending death may seek a take over by another suitable company. Hopefully, with the take over, the already fallen organisation may be injected into good hands of the acquirer.

Conclusion

The rise and fall of great enterprises is fascinating. Any organisation should continue to exist and seek to become great in fulfiling their values, mission and purpose. Once an organisation can no longer serve great meaningful mission and purpose (in the provision of their products and/or services to value add to their market they are serving) thus securing their competitive advantage as market leaders, the organisation will proceed with most certainty the path of decline followed by death. This happens when another organisation which is better able to live out their values to serve similar meaningful mission and purpose takes over from the dying organisation.

All creatures (or organisations) small and large can fall when they do not tread each step carefully. It is alright to encounter small slips sometimes when each slip provides a learning lesson. The danger comes when one ignores the slips and never learn to walk properly which eventually leads to a great fall to one's death.

Leverage - A double edged sword!

2011-04-28T13:08:00.007+08:00

Leverage is a neutral tool available to the investor. It neither favours helping the investor nor harming him. It is a double edged sword. The outcome of using leverage depends on how it is being used by the investor. So, the investor solely controls and is responsible for the outcome of using leverage, whether leverage will help or harm him.

Leverage is powerful in magnifying returns for the investor when it is used in certain situations and on the other hand destructive in magnifying losses when used in uncertain situations. Thus, leverage is a double edged sword and the wielder of this sword has to be trained in understanding how the sword can be used safety so as to help an experienced and knowledgeable wielder of the sword and not harm an unwary novice wielder instead.

One situation that poses uncertainty in using leverage is in trading of stocks. Stock prices fluctuate and when an investor is taking a position to long a stock or short a stock, there is no certainty that the stock will indeed rise (in the case of longing) or fall (in the case of shorting). No matter how an investor can boast of using technical analytic tools as a basis to enter into a trade, there is no absolute certainty that he can always have his way in terms of predicting the exact movement of a stock price. Thus, we hear of the saying "stop loss" and "cut loss" which are simply measures to minimise the impact of loss due to a stock price moving contrary to what is expected by an investor. In such uncertain situation of stock price movement, there is a hidden potential of leverage unleashing it's destructive nature despite having "stop loss" and "cut loss" measures in place as an investor cannot control stock price movements. As soon as a loss is incurred no matter big or small, leverage will magnify the losses further.

However, in special situations such as a high probability of an arbitrage deal being completed, much risk would have been removed though a small risk that the deal may not be completed is still inherent as one cannot remove all risks. In addition, the more certain an investor can ascertain the time of completion of an arbitrage deal, he will be able to determine his adjusted projected annual rate of return (see previous post "A look at arbitrage deals using arbitrage risk equation from Benjamin Graham."). Using leverage in such certain arbitrage deal situations will help to magnify the returns for an investor.

I shall present here an example of how leverage can be used in such certain arbitrage deal situations. ABC company offers to buy all shares of DEF company at $10 per share in an acquisition exercise. DEF company agrees to tender all it's shares to ABC company at this price. Public announcements have been made by both companies and many investors of DEF company have tendered their shares and there is no objections from any major investors to block the acquisition. The acquisition exercise is expected to close in four months. Immediately after the public announcement, shares of DEF company are trading at around $ 9.70 per share.

For an investor who bought DEF shares immediately after the public announcement at around $9.70 per share, he will stand to make a return of about 3% in four months when the deal closes. His annual rate of return will be approximately 9%.

= 3% in four months

Annual rate of return = 3 X 3% = 9%

An annual rate of return of 9% may not make this deal overly attractive. However, the situation becomes different when leverage comes into the picture. Imagine that an investor can finance the buying of shares of DEF company at 8% borrowing interest rate per annum. This equates to a borrowing interest rate of around 2.7% for the four months period of the arbitrage deal. This translates to an interest cost at around $0.27.

Interest cost for the four months = 2.7% X cost of shares
= 2.7% X $9.70
= $0.27

Having an interest cost of around $0.27 per share and a potential profit of $0.30 per share from the arbitrage deal ($10 - $9.70 = $0.30), there will be a projected profit of $0.03 per share ($0.30 - $0.27 = $0.03).

Note that the cost of a share of DEF company is $9.70 per share, but the investor using leverage is borrowing this $9.70 at an interest cost of $0.27. So, his real investment cost is only $0.27 per share. He will earn a projected profit of $0.03 per share from our earlier calculations.

Thus, his rate of return for the four months is approximately 11%.

= 11% for four months

This translates to a whopping annual rate of return of 33% (11% X 3 = 33% in a year). With leverage, the investor can receive an annual rate of return of 33% compared to without leverage at an annual rate of return of 9%. His actual rate of return in four months time from the arbitrage deal is also higher at 11% with leverage compared to 3% without leverage. In this case, using leverage will approximately triple his returns in the same time period.

In conclusion, certainty when combined with leverage greatly magnifies returns for an investor. When leverage is used in certain situations such as a very high probability of consummation of an arbitrage deal within an announced known time period to completion of deal, an investor can determine his projected profit for the time period with high certainty. Leverage can thus be used as a powerful tool to greatly magnify an investor's returns in situations of high certainty. Wield this double edged sword properly with understanding and knowledge and it will greatly reward it's careful user.

Leverage - A double edged sword!

To the knowledgeable wielder who wields the sword (leverage) with understanding, it rewards him greatly!

A look at arbitrage deals using arbitrage risk equation from Benjamin Graham.

2011-04-21T12:08:00.018+08:00

There is a class of investors known as arbitrageurs who invest in arbitrage situations. There are two general types of arbitrage namely "market arbitrage" and "time arbitrage".

For market arbitrage, arbitrageurs seek to profit from price differences in the same security or investment being traded in two different markets. For example, if a company ABC's stock is concurrently being listed and traded in the London stock exchange at $10 per share and the Paris stock exchange at $12 per share, arbitrageurs will step in to sell the ABC's stock at Paris stock exchange while at the same time buy the stock at London stock exchange in order to pocket the profit of $2 per share in price difference. By the act of arbitrageurs, it is rare to see large price differences in any security or investment traded concurrently in different markets since any price differences will be immediately capitalised by arbitrageurs to profit from the price difference and thus the stock price of the same security will be brought towards approximately the same price by selling in one market and buying in another market simultaneously.

For time arbitrage, investors are arbitraging the price difference between what the stock price is today to what it will be at a future time. Many investors are already doing time arbitrage when we seek to buy a stock at today's price and hopefully sell it to another investor who will pay a higher price for the same stock in future (longing a stock) or borrowing and selling a stock at today's price and buying back the same stock at lower price in future (shorting a stock). The future time to fully transact an arbitrage in this case can be as short as one day to months or years.

Time arbitrage (longing shares - buy low sell high,

or shorting shares - sell high buy low)

There are also special situations that will create arbitrage opportunities for the investor. These situations include mergers and acquisitions, securities buybacks or self tender offers, corporate reorganisations, corporate liquidations, corporate spin-offs and corporate stubs. With every potential arbitrage opportunity that comes on scene, there is also an element of risk that the arbitrage deal may not follow through to the end. An arbitrage deal that is created but does not follow through in the end may spell losses for investors who have invested their money into the deal to find that the deal does not work out. Thus, it is important to assess every arbitrage situation carefully to minimise the probability of entering into a losing deal.

Benjamin Graham, Warren Buffet's mentor and friend has an equation that can be used to assess the rate of return based on factoring in risk and reward of an arbitrage situation.

The first part of the equation is to determine the projected profit from an arbitrage situation (e.g. ABC company has announced a tender offer to buy all of DEF company's shares at $10 per share. DEF's shares are currently trading at $9 per share.)

Thus, the projected profit is $10 - $9 = $1 per share.

Next, we determine the probability that this tender offer deal will follow through to completion. Let's say there is a 90% chance of this deal completing. Note that the determination of the probability of the deal completing is more of an art than science since the investor has to assess all information available to him on the arbitrage situation carefully and come to a meaningful conclusion. His probability may differ from another investor's probability due to different views on the same arbitrage situation. We multiply our probability by the earlier projected profit.

Thus, the adjusted projected profit = 0.90 X $1 = $0.90 per share.

Next, we factor in the risk that the deal may fall apart and assume that the share price will return to the trading price before announcement of the tender offer. The risk is a projected loss between the current share price we pay and share price before announcement of tender offer. The current share price is at $9 per share for DEF's shares. Let's say the share price was $8 per share before the announcement of the tender offer.

Thus, the projected loss is $9 - $8 = $1 per share.

Next, we determine the adjusted projected loss. Since there is a 90% chance of the deal completing, there will be a 10% chance of the deal falling apart. We multiply this probability by the earlier projected loss.

Thus, adjusted projected loss = 0.10 X $1 = $0.10 per share.

Next, we determine the risk adjusted projected profit (after factoring in the risk involved in making the profit) by subtracting our adjusted projected loss from adjusted projected profit.

Thus, risk adjusted projected profit
         = adjusted projected profit - adjusted projected loss
         = $0.90 - $0.10
         = $0.80 per share

Lastly, we calculate our risk adjusted projected rate of return (in %) by dividing the risk adjusted projected profit over our original investment of $9 per share if we were to buy DEF's shares to enter into this arbitrage deal.

Thus, risk adjusted projected rate of return
= ($0.80 / $9) X 100%
= 8.9%

An 8.9% return on this arbitrage may not be too attractive over a year. However, if this arbitrage deal can be fully completed and the investor gets his profits in shorter time of six months, then the annual rate of return becomes 8.9% X 2 = 17.8%. This postulated annual rate of return is assuming that the investor can continue to keep his original capital reinvested after completion of the arbitrage deal at the same rate of return (for next six months to make up a full year). An annual rate of return of 17.8% now becomes attractive for an investor. Thus we see that an arbitrage deal becomes attractive should the arbitrage be completed in as short a time as possible.

In using this arbitrage risk equation, one is not trying to be precise in determining the rate of return on the arbitrage as no one can predict perfectly the outcome of any arbitrage situation. Therefore, the principle is to invest in arbitrage deals that have a very high probability of completion. One can be more certain of an arbitrage deal being completed if public announcements are already made and legal documents have been filed to the relevant authorities of securities exchanges.

As an arbitrage deal becomes more certain of being completed with passage of time, the gap in the traded share price to the tender offered share price (for example in the case of tender offers) closes and the traded share price in the open market will come close to the tender offer share price. The careful investor who waits for certainty before commiting his capital into buying the shares will see lesser rate of return.

However, an investor can still magnify his rate of return by using leverage (buying shares on margin) on such certain arbitrage deals. This is where the use of leverage (conventionally thought to be dangerous and destructive) works well in such certain deals to magnify returns. By combining certainty with leverage, this certainly beats uncertainty in the earlier stages of arbitrage when an investor buys on rumors and risk having the arbitrage deal falling apart and the loss on his capital.

How great leaders inspire action? People buy the "why" more than the "what" and "how".

2011-04-13T01:27:00.015+08:00

The title of this post sounds confusing. It is meant to be confusing until you have watched the youtube video at the end of this post. The lessons learnt in this video can be applied to leadership, marketing and life. In leadership, people follow great leaders who know the purpose of "why" he is leading his people, to fulfil a great meaning and vision. The followers understand "why" they want to follow the leader. They are not just only following "what" the leader asks them to do, and the methods ("how") they are going to do certain things. Beyond all that, followers of great leaders know "why" they are following their leaders.

As such, great leaders inspire their followers by making them understand "why" they are following the leaders to fulfil a great meaning and purpose that speaks to their hearts. Once the followers understand "why" they are following a great meaning and purpose do the nitty gritty details of "what" they should do and "how" they should go about fulfiling that great meaning and purpose come about naturally with passion.

How many of us often heard our bosses telling us straight in the face to get certain things done and the methods we should pursue to get things done? How often if any at all do our bosses speak to us about "why" it is so important to do the things we do? Why do we need to work hard on a certain project? Is there a great meaningful purpose behind the project other than to benefit the company with improved sales and profits? Instead of looking only at profits alone, why not question whether doing certain things by a company serve any great meaning and purpose?

A great enduring company looks at a strong meaningful purpose and vision as a foundation to why they exist. They question the reason "why" they exist, to serve a greater meaning and purpose more than just being profits driven alone. A great healthcare company looks to serve their patients in terms of providing premium products and healthcare services to cater to their unique individual needs. This is the importance of questioning the "why" and not just the "what" and "how"(in terms of what medical treatment packages or healthcare products are available for sale and how to make the customers buy the services and products). By answering "why" customers should buy a product or service, a company can better innovate and market it's products and services to answer to the needs of it's consumers instead of convincing the customers to buy into the various features of a product or service that they may not have any needs for.

In marketing terms, the marketer should look to connect with the needs of the buyer. People do not care what you offer until you show you really care. This involves looking beyond the "what" (e.g. What products and services am I offering?). This also involves looking beyond the "how" (e.g. How can I market my products and services to make it attractive to my potential clients?). Instead, it instantly connects if the salesperson speaks to the needs of the potential buyer. For example, an insurance agent first gets to know the client well enough by questioning and listening to understand where are the needs of the client and why the client will need certain products or services before offering him the relevant insurance products and services that can meet his client's needs. The agent is not trying to convince his potential client of the good features of his products and services, but is only offering relevant products or services he believes can help answer the specific needs of his client.

In all the decisions and actions, this insurance agent is questioning "why" his potential client should buy certain products and services from him. He also understands fully and cherishes the meaning and purpose of "why" he is doing his trade. He does not see his trade as just a day job, but the job offers him an opportunity to fulfill a great meaning and purpose to help as many people he will meet. He hopes to help all his clients become financially better and also insured appropriately so that his clients' own and/or related family's future financial needs are covered against any unforeseen circumstances that threatens the basic survival of the client and/or family. He is working hard to meet the needs of his clients simply because he believes what he is doing will benefit as many people as possible instead of seeing it as only meeting his monthly sales targets and commisions. He is not constrained by only the "what" and "how" in his trade, but is inspired by the "why" of doing what he does.

Many great inventors also cherish the question "why" they are working on any great ideas. The Wright brothers set their dream on seeing man take flight opening another new method of travel never before when they invented the very first prototype of the more advanced airplanes we see in modern times. They persevere despite many failures until eventual success. "Why" do they persevere? They believe their dream of one day seeing man take flight into the air will change the course of the world. In the words of Orville Wright, "The desire to fly is an idea handed down to us by our ancestors who, in their grueling travels across trackless lands in prehistoric times, looked enviously on the birds soaring freely through space, at full speed, above all obstacles, on the infinite highway of the air."

Perhaps it is time to ask ourselves "why" we do certain things in life. It is important to reflect every now and then on "why" (the meaning and purpose) we are working on certain things to inspire our actions - the "what" and "how" things can be done. Asking the question "why" works in leadership, marketing and all we do in life. By asking "why" each time, one can be inspired to persevere in fulfilling great and meaningful purposes in life for ourselves and people around us.

Does growth adds value or destroys value?

2011-04-06T03:51:00.016+08:00

All businesses experience growth. If a business does not grow at all to aspire towards becoming a market leader, it is just a matter of time when a competition catches up and takes over the competitive advantage of an existing business. Some companies grow for the better creating more wealth and shareholder value while other companies destroy wealth and shareholder value as they grow. Thus, there is nothing great about growth if growth does not create more wealth and value.

How do we distinguish good growth from bad growth? To understand the distinction, we look first at a company with balanced growth. A company with balanced growth will increase it's revenue and other items in the financial statements such as net income, equity, liabilities and total assets at the same percentage every year. This means that the ratio of such important items in the financial statements to revenue remains the same every year. Other metrics like net profit margin and return on equity remains constant.

For a balanced growth company, the steady increase in revenue and net income makes the company more valuable through the years. However, the trade off is that the company has to maintain this growth with new capital every year that grow at the same rate as the growth in revenue and net income.

A typical balanced growth company has the characteristics on it's financial statements as follows. To make things simple, this company is assumed to be without debts and has only equity as the sole consideration for it's capital invested.

For this example of a balanced growth company, revenue, net income, equity and the amount distributable to shareholders (amount distributable to shareholders is calculated from net income minus additional required capital investment in the form of equity) all grow at similar rate of 10% per annum. Net profit margin and return on equity are relatively constant at 10% and 20% respectively.

To calculate the present value (PV) of the distributable cash flow to shareholders, one can use the formula as follows.

PV = C X [(ROC - G) / (R - G)] ,

C is the amount of capital at the start

ROC is the return on capital

R is the cost of acquiring capital

G is the rate of growth

For this balanced growth company, it's return on capital (ROC) is 20% (same as it's return on equity) since it is assumed to have only capital in the form of equity and no debts. It's capital at the start (C) is the equity it has which is $100 million. It's rate of growth (G) is 10% since it grows it's revenue and net income at 10%.

Where growth does not add value nor destroy value

For the case when the return on capital (ROC) is equal to cost of acquiring capital (R) (e.g. both ROC and R are 20%),

PV = $100 million X [(0.20 - 0.10) / (0.20 - 0.10)]

= $100 million

Thus, the present value (PV) of the distributable cash flow to shareholders ($100 million) is the same as the amount of capital invested by shareholders at the start ($100 million). The shareholders do not get more in present value of distributable cash flow as compared to their capital invested at start. This means that the company does not add value nor destroy value for it's shareholders even with a 10% growth rate of it's revenue and net income.

Where growth adds value

For the case when the return on capital (ROC) is more than the cost of acquiring capital (R) (e.g. ROC at 20% and R is 12%),

PV = $100 million X [(0.20 - 0.10) / (0.12 - 0.10)]

= $500 million

Thus, the present value of distributable cash flow to shareholders ($500 million) is higher than their capital invested at start ($100 million). This means the company adds value to it's shareholders even with a 10% growth rate of it's revenue and net income.

Where growth destroys value

For the case when the return on capital (ROC) is less than the cost of acquiring capital (R) (e.g. ROC at 20% and R at 22%)

PV = $100 million X [(0.20 - 0.10) / (0.22 - 0.10)]

= $83.3 million

Thus, the present value of distributable cash flow to shareholders ($83.3 million) is lower than their capital invested at start ($100 million). This means that the company destroys value to it's shareholders even though there is a growth rate of 10% in revenue and net income.

Conclusion

It is time to debunk the belief that all growth creates value for shareholders. Growth of a company usually requires some amount of additional investment of capital (be it in the form of equity or debts). Financiers of equity or debts will require their interests or returns on their capital provided to the company. This is the cost of acquiring capital the company has to bear in order to allow growth to be possible. When a company requires a higher cost of acquiring capital compared to the returns on acquired capital in order for growth, then growth may not be that good afterall since it destroys value for shareholders. Thus, the next time a company speaks of magnificent growth plans, it is time for a potential investor to look deeper into whether growth does creates value or not.

Termite infestation, a case where rapid growth destroys value.

Is there value in using dividends to valuate a company?

2011-03-19T03:57:00.004+08:00

In my previous post, we challenged the long-held belief in looking at annual rate of return on investment as a measure of investment success. Maybe there is another way to rethink the notion of investment success by looking at how fast one accumulates his investment capital over a period of time (his rate of accumulation of capital)? On this same note, perhaps there is some value in seeing dividends serving this purpose of capital accumulation by reinvesting the earned dividends back to increase one's portfolio value and also work on the principle of compound interest growth to further receive more future dividends upon a larger portfolio with the reinvested dividends.

It is no wonder that compound interest growth is the 9th wonder of this world - principle of interest received upon interest reinvested. The higher the amount of interest in consideration and the higher the rate of interest received, the faster this 9th wonder of the world works to double the original capital value. One may have already heard of the principle of 72 in calculating the number of years needed for one's capital to double by compound interest growth. Just divide the number "72" by the compound interest growth rate and one will know how long it takes for an original capital sum to double. E.g. if one can receive a consistent compound interest rate of 10% annually, it will take approximately 7.2 years (72 / 10 = 7.2 years) for one's original capital sum to double assuming all dividends received from one's portfolio are reinvested.

If one started with a $100,000 capital sum, 7.2 years later he will have approximately $200,000 by compound interest growth at 10% compounded interest rate. One can imagine the effect is enormous when dealing with larger capital sum. A starting capital of $500,000 in the same case with be worth $1 million in approximately 7.2 years time.

The two important factors here will be the amount of start-up capital and compound interest rate. Many of us are limited by our start-up capital. Not all people start on the same equal footing. Some start on a more substantial capital sum while others start with a smaller sum when embarking on this journey of investment. Since one is limited by his start-up capital, the second factor (compound interest rate) now plays an important role in determining how fast one can keep doubling his capital.

How nice if one can continue to receive year after year dividends that grow at a rate faster than inflation? The higher the annual rate of growth of dividends, the higher the compound interest rate one receives if one can successfully reinvest all the dividends consistently at high yields. Therein lies the importance of dividends, especially dividends that prove to be consistently growing at high rate annually.

However, there is another perspective in some investors preferring the company not to provide dividends but instead reinvest it's earnings to grow it's business competitive moat and assets so as to generate even more future earnings and potentially increasing the share price. If the company can do a better job at reinvesting it's earnings to generate better future returns for it's shareholders than they receiving the dividends which they can only reinvest at lower returns, it maybe better for the company to do so. The future is unknown, so the merit of whichever choice be it for a company to provide some dividends out of it's earnings or to reinvest all it's earnings is known only on hindsight.

Since dividends may be considered as important and a consistently growing dividends at high yield annually is desirable, one can use dividends as a means to valuate a company's intrinsic value per share.

The relevant equation adapted from dividend discount model (DDM) to estimate a company's intrinsic value per share is as follows:-

R = Cost of capital

G = Compounded growth rate of dividends

Just a simple case study for estimating the intrinsic value per share for one of my invested companies, Keppel Corporation. Keppel Corp has seen it's dividends grow at a compounded rate of around 11% over the past 7 years. It's most recent dividends is $0.42 per share. I shall use a cost of capital of 14% as my opportunity cost in investing in Keppel Corp.

Putting all the information into the equation gives:-

= $14

Intrinsic value per share is only at best an estimate. If one uses a higher cost of capital (e.g. 15%) in the equation, the estimated intrinsic value per share now becomes $10.50. The current market price for Keppel Corp's share is $11.40 per share. So, if one uses a higher cost of capital (15%), the estimated intrinsic value per share is lower at $10.50 and now Keppel Corp's current market share value seems to be overvalued. But, if one uses a lower cost of capital (14%), Keppel Corp's current market share value of $11.40 per share will now seem to be still undervalued compared to estimated intrinsic value of $14 per share. Thus, estimation of intrinsic value per share is only a subjective fuzzy guide. The investor needs to invest at a valuation much lower than the estimated intrinsic value per share to ensure a margin of safety.

The value in looking at dividends in estimating intrinsic value per share for a company is that one is also looking at the track record of the company in giving dividends. A good track record is always welcomed. A company like Keppel Corp that has provided a good 7 years of dividends that grow at a compounded annual rate of 11% may have a fair chance of continuing it's track record. Of course, in everything due diligence is needed to also look at other aspects of a company and not it's track record in dividends alone.

In conclusion, is there value afterall in using dividends to valuate a company? Is dividends valuable to an investor? Yes, it is valuable to a certain extent as long as the company can continue to provide a reliable stream of dividends that grow at a high annual compounded rate. Even better is the investor that continues to receive that stream of dividends at a high yield (more than 10% annually).

How to know whether an investor has succeeded??

2011-03-10T01:28:00.009+08:00

It is known to many that one looks at investment success in terms of rate of return on investment. If an investor can receive consistent annual high rates of returns on his original capital, he is deemed to be successful. The higher the annual rate of returns and the more consistent he can keep receiving the high rate of returns on investment, the more successful he is.

This brings us to the question of whether this long held belief is a good measure of investment success or not. I believe there is no harm in challenging every beliefs in life, and that includes investment beliefs as well. By challenging beliefs, one is not trying to be difficult and go against the beliefs but rather to seek the truth, to see whether the belief in question is really the ideal truth or not.

Is annual rate of returns on investment a good measure of investment success? Let's look at two separate fictitious people, Alan and Jane who did their investments differently. Alan is an investor who goes for high annual rate of return on his investments. He recognises the need to invest long term in good dividend stocks that provide a high yield. He also recognises the need to go for high capital gain every year, so he carefully selects some stocks that he thinks have good potential to grow their share price in any year. Alan has been doing well so far, getting reasonably good average annual rate of return (around 18%) on his original capital though his rate of return may change every year.

The only thing about Alan is that he reinvested little of his earnings from investments, so his investment capital value has not grown much throughout the years even though he continues to receive dividends and capital gains yearly which he spends away most of these earnings. When Alan talked to his friends about his investments, he always smiled with pride that he managed to get consistently good average annual rate of returns.

Jane another investor shares the same investment thoughts as Alan carefully selecting good dividend stocks with high yield to invest for the long term. She also looks out to invest in good growth companies that show potential to increase their share price be it on short term or longer term. In doing so, she is also hoping for good capital gain on her investments apart from receiving cashflows from dividend stocks. She is not as good as Alan in getting a high annual rate of returns on her investments. She managed to receive on average around 11% annual rate of return on her investments. She diligently reinvest her earnings from investments throughout the years during opportunate times when valuations of companies are cheap.

Alan started with $100,000. After 20 years, his portfolio investment value has grown to $300,000. Jane started also with $100,000. After the same 20 years, her portfolio investment value has grown to $800,000. So, at the earlier part of both their investing journeys, Alan seems to be the better investor getting a higher average annual rate of return on his investments than Jane. However, he only reinvested little amount of his earnings from investments and mostly spends the rest of his earnings. He was thinking to himself all along that he was successful at getting a high average annual rate of returns on his investments.

Jane recognised the value of compound interest growth, so she delays her immediate gratification on spending her earnings from investments and instead plough back her earnings from investments to work on the principle of compound interest growth. Her efforts are finally realised only after a sufficient long period of consistent and diligent reinvesting, greatly increasing her original capital sum.

She has a higher capital value in investments than Alan after 20 years even though she made lesser average annual rate of returns on her investments throughout this period. In doing so, she managed to have a higher rate of accumulation of capital compared to Alan over the same period of time for the same start-up capital, since she has accumulated a capital sum through investing which is much higher than Alan.

I shall leave you with a final question. Is annual rate of returns on investments really a good measure of eventual investment success or maybe it is time to relook at this long held belief and consider another possible measure, the annual rate of accumulation of investment capital?

4 risks that entreprenuers and businesses face.

2011-02-24T11:31:00.007+08:00

There are four ongoing risks that entreprenuers and businesses alike will face. I call these four risks the "Big Four". These four risks are also inevitably faced by investors who invest in any companies. For an investor, one will like to consider the nature of the invested company and amount of exposure to each of these risks, and also the ability of invested company to deal with these risks.

Here are the Big Fours:-

1. Funding risk.

2. Market risk.

3. Timing risk.

4. Technology risk.

1. Funding risk

Every company be it start-ups or established ones requires some amount of funding to continue it's operations. It is rarely that a company can continue it's operations just on past retained earnings alone. This is especially true if the company is on an agressive growth phase. It is inevitable that such a company will need to tap on external funds in addition to it's internal funds to grow and expand it's business. For any business, the ability to establish multiple lines of credits, equities and loans become necessary to fund it's operations and growth. It is important that a company is able to seek out multiple funding sources and maintain a health ongoing relationship with it's creditors and equity owners, while at the same time estabilshing credit trustworthiness so that it has multiple funding sources to tap into either to continue it's operations or grow the business.

If a company is unable to seek out enough sustainable long term funding sources, this may jeopardise the ability of the company to continue it's operations, not to mention growth especially if the company cannot sustain it's operations and growth by internal resources (e.g. past retained earnings). In any case, even if a company has established mulitple funding sources, the company should be also careful in maintaining a healthy debt level so that it is still able to service it's debt interest and loan payments on time. Many a times, it is not the inability to establish multiple funding sources, but rather the inability to service debts that leads to the downfall of many companies, start-ups and also large businesses.

2. Market risk

Market risk refers to whether there is a market for the products and services of a company. It is prudent for any company to be able to understand the needs of it's target market well so as to roll out relevant products and services for it's consumers. It is not what the company thinks about how good it's products and services are, but rather how the targeted customers think about how good and relevant the products and services are to them that results in sales and revenues on the products and services. It is not easy for any company to understand the market needs despite doing extensive market research and checking with it's potential market.

In addition, needs and consumer behaviour of a potential target market may also change over time (sometimes even within a short time frame) rendering the products and services of any company irrelevant. Thus, like it or not, all companies constantly face the risk of it's products and services becoming irrelevant or less appealing to it's target market. This is especially true with so many competitors out there vying for a pie of the same market, thus making it even more difficult for any company to not only constantly improve and roll out relevant products and services for it's target market but at the same time having to compete with it's competition on the ability to reach the target market to secure market share.

An example of market risk is found in the many mobile phone producers that need to constantly compete to secure and enlarge their market share by always innovating their mobile phones to be more appealing in looks, functionality and catering to lifestyle needs and wants of consumers.

Other unforeseen factors can also present a market risk to any businesses. For example, a change in demographics such as a low birth rate in a local population over time may mean that businesses selling maternity products or providing child related services will see a shrink in their market size. Another example may be a change in government laws and regulations such as banning of consumption of chewing gums in Singapore which means businesses can no longer sell chewing gum products in Singapore thus removing totally the market for chewing gums in Singapore.

3. Timing risk

Timing risk refers to the risk of the products and services being introduced into the market at the wrong time or too slowly. For competitive products like mobile phones, the better the mobile phones and the faster the phones can be introduced into the market for a mobile phone producer will allow it to capture market share ahead of it's competition. It is thus easy to understand why Apple has introduced it's line of iphone products from iphone 3 to iphone 4 to iphone 5 at close timings. This is done to protect and also enlarge it's market share to prevent other competition with coming out similar phones to compete with Apple. By flooding the market at close timings with it's line of iphone products, this ensures Apple's current consumers will continue to upgrade their iphones to the next better iphones without leaving them a chance to consider other brands when other mobile phone producers have finally caught up with producing similar lifestyle phones to compete with Apple for market share. Thus, for such companies like mobile phone producers, the faster one to make the appeal may really make the appeal. Sometimes, it may not be the best quality products or services that can get the market, but the faster company to make the appeal of it's products and services will get the market.

There is also a need to determine the right timing to introduce products or services to the market. For example, a face mask company ramping up on it's production of face masks during SARS period will see their sales and revenues sky-rocket. Other times, it may not be wise for a company to be producing at such high quantities especially if the products have a limited shelf-life. This will mean wastage and lost of money for the company.

4. Technology risk

This risk is relevant for any companies that require technology in their operations and/or technology is found in their products and services. Any company will require some form of technology in their operations and manufacturing of products. All companies face the risk of their current use of technology becoming inferior or obselete to keep up with the technology of it's competition and also to answer ever changing needs of consumers. Technology risk is especially high in companies that require high amounts and level of technology in their operations, manufacturing process, and also on their products and services that compete on technology.

One example of high technology risk faced by companies is found in the digital media recording industry. We have seen how the very first video tapes are made obselete by the coming of a new and better technology in media recording, the compact disc format. Now, the compact disc format is slowly facing the same fate as the early video tapes as they are replaced by DVD format. There are also other better technology products around in the market such as the Blu-Ray disc format which may become the commonly used technology in future thus leaving the rest of the past media recording formats to permanently bite the dust.

Therefore, companies that deal with high technology in their operations, manufacturing processes and/or in their products and services will constantly face the risk of their technology becoming obselete with time. When their technology becomes obselete, companies have to spend on replacing their obselete technology with more current ones

Conclusion

Risks are always inherent in any businesses. A company has to be constantly aware of the types of risks that it faces and have measures in place to mitigate problems that may arise from the risks.

On bonus issue.......Is it really a bonus?

2011-02-15T11:47:00.004+08:00

I received announcement from one of my invested companies that it is issuing a bonus issue. There are always bound to be some interesting questions to an investor whenever a company raises any corporate announcements, in this case a change to it's capital share structure.

Is bonus issue a good thing or bad thing? I believe different people will have differing opinions on this. I am not trying to arrive at a definite answer because again different people will have their opinions on this, and neither one is correct nor wrong since it is just different perspectives to see the same issue (bonus issue).

A bonus issue is a method a company disburses it's dividends to shareholders in the form of shares instead of cash dividends. From my research, a company can choose to give out bonus issue instead of cash dividends to conserve cash. Does this means that a company must be cash tight in order to give out bonus issue? It is not always the case that a company must be cash tight to resort to bonus issue to reward it's shareholders. A company can give out bonus issue if it is trying to save cash for it's near future growth which may require large amounts of cash. So, giving out bonus issue does not necessarily mean a company is short of cash to resort to this measure to reward it's shareholders. A company may give out bonus issue to serve both functions of rewarding it's shareholders and conserving cash for deploying it in some targeted future growth opportunities.

As such, bonus issue is also considered as a scrip dividend whereby dividends is paid out in the form of shares instead of cash to it's shareholders.

Are there any other effects of bonus issue apart from shareholders expecting to receive dividends in the form of shares? Yes. Other effects include an increase in the number of shares since new shares are issued to shareholders in the form of bonus issue. To this, I believe there is no dilution of shareholder stake in the company since every shareholder is entitled to the same proportion of bonus issue with regards to their existing shareholding. However, another effect of bonus issue is the short term reduction in share price in proportion to the increase in number of shares through bonus issue.

Other effects include an increase in liquidity of the traded shares since more shares including the bonus issue will be now in the market. With the increase in the number of shares, investors should note that many financial ratios may be affected to a certain extent (especially if the increase in the number of shares through bonus issue is a large proportion to existing number of shares) such as a reduced earnings per share (EPS), reduced return on equity (ROE) and for value investors - a reduced estimated intrinsic value per share etc.

For me, the way I see bonus issue will depend on which company is issuing it. If a company with good growth and fundamentals is giving out bonus issue with the intention of rewarding it's shareholders, this is certainly welcomed. On one hand, there is no dilution of my shareholding and on the other hand, I get more "free shares" in the company. Some may have a counter arguement that what is the point of getting more "free shares" if the EPS and ROE will be reduced. This may be seen as just a short-term gimmick which does not have any practical profitability for the investor.

However, I already mentioned before that it all depends on which company is issuing the bonus issue. If a company is showing a good track record of consistent growth in it's EPS and also maintenance of strong ROE coupled with it's good business fundamentals and prospects over a good number of years (at least 10 years), there is a case for forecasting that the company can continue it's growth and profitability in years to come. In this case, "more of a good thing is a good thing". Owning more shares in the company can mean that the value of each share will increase in time to come. The short-term effects of reduction in EPS and ROE will be overcomed easily for a company that shows strong growth and profitability, especially when the proportion of bonus issue to the existing shares is not significant at all.

In conclusion, it all depends on who is issuing the bonus issue, a good company or a lousy one. Give me more of a thing that has good increase in future value and I will treasure it. Give me more of a thing that will in future depreciate in value, and I will be very sick to ask for more. An investor sees value when investing.......

Summary of effects of bonus issue:-
1. Increased number of shares in the company.
2. No change in stake of existing shareholders (though each shareholder now owns more shares "given free").
3. Reduction in various financial ratios such as EPS, ROE etc.
4. Reduction in estimated intrinsic value per share (applicable for value investors).
5. Reduction in share price after bonus issue (in proportion to the increase in number of shares).
6. Dividends paid out in the form of shares instead of cash (helps company to conserve cash).
7. Conserving of cash by company for future use (in growth opportunities??).