Wednesday, August 03, 2022

Why you will fail at Value Investing - part 2


If you think that Part 1 of this series makes Value Investing look impossible for retail investors, part 2 would be even worse, we will be looking at Management Quality in this installation.

Management Quality in this book is divided into two parts :

a) Does Management think and act like owners?

In this section, an investor needs to read management's minds. Somehow, you need to find out whether management acts for themselves or their shareholders. There are of course some hints at how to do so, one possibility is to see whether management owns the company shares and will benefit when the share price goes up. Another is to see whether there are any incentives to skew their behavior, like stock options. 

Notwithstanding, you need to be able to tell whether the manager is working for the shareholder or for himself, even though this may not be mutually exclusive. 

b) Do executives understand what drives business value?

This is even harder, as some retail investors may not understand what drives business value, but it is at this point where the book really starts paying for itself. The author likes company bosses this really sharp question, which is more important? (a)  growth in sales/profits or (b) return on capital ?

The correct answer is (b), because, with enough capital, you can generate any amounts of growth to your sales or profit. But high return on capital may evince a sustainable competitive advantage.

The best managers are, therefore, those which are most adept at managing capital. This means that speculative R&D projects with little pay-off need to be traded off for projects which can potentially bring value to the company.

Bringing this central idea to the local markets, I'm afraid that I am only aware of one local boss that meets the bill - Andy Luong of UMS, but this is after the fact. I have earned so much from his stock splits and generous dividend payouts, of course I have a great impression of him. I don't have clout to now enough bosses to know who else hits the bill. UMS is hardly a perfect value stock as it is bogged down by having just one major customer.

I also like Mohd Salleh of Second Chance but that's because of his candour and his public admission that, like me, he loves dividends, I would not say that I've made much from my Second Chance holdings.

[ All this being said, I noticed that Lim Chung Chun CEO of iFast seems to have the same psychological make-up as my business partners who I count as allies closer than friends. I also derive income from iFast these days. The question is whether is he an efficient capital allocator? Or I'm just biased because I make money from them? ] 

While it certainly sounds that management quality is a powerful determinant of investment success and may actually justify paying for active management skills, management itself can be subject to change. Some bosses grow old, fall sick, and make mistakes in secession planning, other's become obsolete and allocate capital as if things are 20 years ago. 

Worse, I've seen so many proponents of management quality generate such bad returns because it takes so much effort to understand management well, these analysts may become fixated with a stock due to the sheer effort put into analysis. If you see some "F" in their MBTI, I notice that emotions can hijack their portfolio decisions quite readily for folks who claim that they are great analysts. 

Companies are companies, you should be ready to move your capital out if your investment thesis is no longer valid. 

Companies are not your girlfriend, but MBTI folks with a "TJ" (folks who read this blog) would be happy to dump a girlfriend if a better person comes around. 

Is value investing a construct to create the illusion for "feelings" people to have credibility in the investing world?

God knows.


  1. Discussing "management" is subjective and can mean anything....

    For SGX REITs, a quick objective shortcut to check management quality is to see:
    a) How many of their past acquisitions have been accretive on a DPU basis?
    b) Are are the management fees structured to align their interests with minority shareholders? ie: They are paid performance fees on Distributions *per unit*, not just total distributions or AUM (which encourages reckless expansion).

  2. "Is value investing a construct to create the illusion for "feelings" people to have credibility in the investing world?"

    You triggered me! You just described the whole finance industry.
    - ILPs are personally sold to you by agents who pick on your fears. You really just get a mass produced product, based on stock/bond/derivative returns, with so many layers of fees slathered on top that you can't recognise the underlying product.
    - Unit trusts are sold by reputable organisations with big offices, with the story-of-the-month (Green EMs in China....). Just a glossy cover over unpredictable stocks.
    - Quants produce solid-looking numbers and charts, giving a level of certainty to their backtests. Which doesn't exist. Try finding someone who backtested against the 1987 crash.
    - Indexers tell you that time in the index beats everything else. Measured over a period where passive investing has continually gained market share over active investing. What happens everyone holds the same S&P 500 stocks and that trend reverses?

    The whole financial industry exists to hide the inherent uncertainty of markets. Everything in the markets works till it doesn't, but you can't tell that to retail investors. Lipstick on a pig. There might be a place for someone who can bridge the gap to present the risks and rewards honestly to reasonably intelligent people. But since the industry isn't full of can't be that profitable!

    I found value investing usually only works for a few companies whose profits are predictable (maybe < 5% of all companies), or at a few rare times (a recession, once every 3-10 years). It tells you that your stock won't go to zero and will generate some minimal level of profits.