How can low risk lead to high returns?

I received an very interesting private message from a reader yesterday which asked a rather good question, so I'd like to share my reply with everyone here.

The question goes like this:

{Quote)

Your posts are mainly really on penny stocks. Sapphire. yongnam.. (besides osim which u are not recommending a buy)
But you said "High returns Low risk" ?

I just find it a little contradictory. Maybe you can enlighten me a little.

(Unquote)

One of the most common things we first learn about investing is this phrase: Low risk leads to low returns, and high risk leads to high returns. I want to say that the statement is absolutely true, but we must view it in the correct context. The statement does not refer to stocks alone, but the entire investing universe of investment assets.

What it means is that investing in higher risk assets like stocks, derivatives, commodities, etc will give you higher returns, whereas investing in lower risk assets like bonds, fixed income instruments, etc will give you lower returns. Based on the statement, all stocks are considered as high risk assets, and it does not matter whether they are blue chips, penny stocks, index stocks, SESDAQ stocks, and yes, even REITs are included.

Let me address the second part of the question now. There is another common perception that blue chip stocks and/or high dividend yield stocks are less risky compared to penny stocks. In my opinion, this perception is completely untrue. Why do I say so?

Firstly, we must understand that as long as we invest in stocks, we are taking on a significant amount of risk already in factors like poor management, industry slowdown, natural disasters, etc. These risks are beyond our control, so excluding those, the biggest risk involved with stock investing to me is lack of knowledge. I touched on it in another post here, but the basic idea is that if you don't know what you're doing, you wouldn't know what to buy, when to buy, when to sell, and if you make any profit is is only down to luck, and we all know that luck will run out sooner or later.

Secondly, making money from stocks is based on this very simple concept: you make money when the price goes up, and you lose money when the price goes down. Based on that, a low risk stock would be a stock whereby the possibility of the price going down is very limited, right? But in a market correction, we all know that even solid blue chip stocks like DBS can fall as much as Yongnam or any other small cap or penny stock. Simply put, all stocks will suffer, regardless of whether they are blue chip or penny. Anyone who wants to invest in stocks must understand this concept: As long as a stock is expensive, the risk of the price going down is very high.


Thankfully, there is a solution to that, and that is to buy undervalued stocks. This simply means that if you buy a stock cheaply enough, it is less likely that it will go down in price. Take DBS as an example again. Because DBS is a stock, investing in it will carry all the risks normally associated with stocks. And if you buy it at $25, don't you agree that you are taking quite a risk because the possibility of its price going down is quite high? However, the risk is almost minimal if you can buy it at $5 because it is highly unlikely that the price would go much lower than that.

With regards to my strategy, I believed then that buying Yongnam at 3cts was a very low risk investment because after considerable analysis, I concluded that the price would not go down much further. On the other hand, I considered DBS at $20 a riskier investment because it could very well go down to $16.

Adding on, that also does not mean that a stock is more undervalued simply because it is cheaper. How much a stock is valued depends on factors like its owned assets, it cash holdings, and its profits generated. Based on those factors, if a stock was valued at $10 , it would be undervalued at $5. But if a stock was valued at 1 cent, then even 20 cents would be overvalued for it.

I hope that helps to explain how I determine whether any stock, blue chip or penny, large or small cap, is risky or not. I know the explanation is a little lengthy, but if you don't understand it at first, try reading it over a few times. The best way to understand it is to actually own stocks are to experience the fluctuations yourself. The concept will be easily understood then.

Sapphire, Plato & Acma - 3 hot penny stocks.

Although I'm primarily a fundamental investor at heart, I do also know that the stock market is very sentiment driven, and good profits can be made by following the trend and momentum. For example, I currently have a long position in Auston although its fundamentals are weak and it is loss making, but because the demand for the stock is very strong and that pushes the price up quickly. However, I strongly discourage anyone from going into short term stock trading unless you can meet these strict criteria:

1) You are not emotionally capable of separating your stocks into those you invest long term and those you trade short term.
2) You do not have strong risk and money management and have the knowledge of entry and exit strategies and have the discipline to apply them.
2) You do not have the time to monitor the stock market closely from opening to closing.
3)You do not have a decent understanding of technical analysis.
4) You do not have access to software which allows you to monitor the buy and sell queues of stock, the time and sales of the stock, and the intraday & weekly price charts, all in real time.

With that said, I want to look at 3 penny stocks that have been in demand for the past month or so.

Sapphire:


Price change: $0.01 on 1st Nov 2006 to $0.03 in 29th Dec 2006. A 150% gain.

Sapphire is a local construction stock whose main projects in the recent years since 2000 have been repair and redecoration work for old HDB estates. This is not exactly lucrative work, and it shows in their financial statements.

Based on its 1H2006 results in August, its full year result estimates are as follows:

(Estimated)
FY 2006 Revenue: $3.7m
FY2006 Profit: -$1.4m
Current cash position: $0.5m
NAV: $0.0026
FY 2006 EPS: - $0.0004

With such hopeless results, its simply amazing how Sapphire can command such a demand for its stock despite the bullish sentiment for the construction sector. The only possible reason I managed to unearth is that in 1998 when its business was at its peak, it registered a revenue of $217m, which is almost a 75x increase from its current revenue. A return to those glory days would certainly bode well for the stock.

However, we must also note that the situation in those days were a lot different. companies in financial difficulties often place out new shares to raise capital to stay afloat. I'm not sure if Sapphire had done so, but based on the fact that its current share issue stands at 3,837m shares, the probability is very high.

Furthermore, it is planning to place out more new shares which would raise the share issue to 4,003.7m shares, which would only further dilute the existing shares and significantly lower its EPS (which is bad enough as it is) and make it harder for the company to turnaround.

As a comparison, Yongnam only has a share issue of 745.8m shares, and its estimated FY2006 revenue stands at $145.6m, profit at $5.6m. Based on fundamental comparison, there is no way Sapphire can repeat Yongnam's performance.

However, its recent price performance says otherwise, and perhaps Sapphire may have an ace up its sleeve that we retail investors do not know of. As such any buy into Sapphire carries a significant amount of risk to me and that risk has to be managed well if you don't want the stock to slaughter you.

Plato Capital:


The chart does not reveal the full picture for this stock. In mid Nov 2006, it had a share consolidation of 1 share for every 2 shares, which basically means that every 2 shares you hold have combined to be come 1 shares. That implementation resulted in a one day fall from $0.107 to $0.055 accordingly, but it has since recovered back to $0.10, which means that it has also risen some 150% in about 2 months.

It was previously a languishing IT solutions provider, but on 21st Nov 2006, it completed the incorporation of its new current name, Plato Capital Advisory Pte Ltd, and switched out of its traditional business to move into fund management.

With all the recent changes to its share structure and business, it is impossible and rather pointless to judge it on its financial figures. However, it is obvious that the demand for the stock is there, and that it is strongly endorsed by the more experienced shareinvestor forummers. Besides, its share issue is relatively small at just 256m shares, which could explain its price rise since demand will easily outstrip supply.

This could be worth a punt if you don't mind the risks of 100% uncertainty.

Acma:


Price change: $0.04 on 1st Nov 2006 to $0.08 in 29th Dec 2006. A 100% gain.

Acma's first price surge was from $0.04 to $0.06 on 30th Nov 2006, when it announced a placement of 68.5m new shares at $0.06 to an Alpha Securities Pte Ltd and 4 unnamed private individuals. Thereafter, it remained at that price level all the way until 29th Dec 2006, when it surged again up to $0.08 on that back of exceptionally heavy trading volume of 42m shares transferred.

So is it that is so special about Acma? Frankly, if you look at its financials and reports, nothing at all. It is an investment holding company whose main business is in plastics manufacturing, which it has 8 factories across the world. The business is terribly unexciting and its financials are just as bad. Estimates based on its 1HFY2006 results suggest that it will register a -$8.2m loss on the back of a revenue of $178.4m. Its cash flow position is also negative, at -$3.2m.

There is nothing at all to suggest this stock is worth looking at. However, there must be something there to convince those placement investor to pay such a high price premium for their shares. The only problem is that we retail investors are completely in the dark.

Personally, I have no intention of buying in yet, but I will be monitoring it from now on to see if anything else comes up.

Happy New Year

Here's wishing everyone a very happy and profitable 2007 ahaead!

Be cautious. Be very cautious.

Whilst all the mass media and analysts are predicting a rosy outlook for equities in 2007, a lot of the more experienced investors I know, including myself, are of the opinion that a market correction could possibly take place as early as January.

The biggest reason is that almost every major global market, including the STI, has risen too fast too furiously in the past 2 -3 months, and tellingly, the prices for the 50 index stocks that make up the STI have perhaps moved ahead of its fundamentals and are trading ahead of their historical PE ratios. Just look at how steep the recent rise has been. You know the saying "the higher the rise, the harder the fall"? Well, it is quite often true.

Looking at my portfolio, it may seem as if my outlook is very bullish, but in fact, I have sold almost $50,000 worth of stock (although some of it was used to buy Eastern) so in fact, I've actually been reducing my exposure.

However, my outlook is definitely not all gloomy. I've only been selling some of my poorer performing stocks so that if a correction does occur, I will have extra capital to buy better stocks at cheaper prices.

I I still think that we are in the midst of a bull run which has some more legs to go, and my view of an impending correction is only a short term view only because it is long overdue. In fact, I would say that it is even healthy.

My purpose of this post is not to encourage people to take profit and move out of equities. Instead, its to discourage people from throwing large sums of money into the stock markets at this point. Now is not the time to be gung ho.

Is OSIM a bargain now?

Ever since OSIM announced its disastrous 3Q2006 financial results on the 26th Oct 2006, its share price has plunged down by some 30% in two months from $2.05 to $1.40.

At the current price, every investor must be asking themselves if the stock is now a bargain or a stinker. As usual, there are two separate camps of investors: the bulls and the bears.

The bulls comprise of OSIM supporters who believe that OSIM is a well managed business helmed by a messiah in Ron Sim, who seemed as if he could do no wrong ever since OSIM listed in 2000. They believe that OSIM has grown from a niche Singapore brand to a globally recognised brand, and that its strong branding enables it to command its high price premium. They also believe that Brookstone will eventually integrate itself with OSIM's core business given time and that the acquisition will spur its future growth in the North American markets.

On the other hand are the bears. They comprise of OSIM detractors who believe the OSIM faces two big hurdles. Firstly, even if Brookstone does manage to integrate itself with OSIM, the risk remains that the US economy is due for a slowdown and retail sales will definitely be directly affected. Secondly, OSIM is facing intense increasing competition from two ends: the emergence of Otto, a direct competitor, as well from the illegal piracy of its products. Both these factors are slowly beginning to affect its sales and margins, and it is difficult to see how OSIM can counter the problem, especially with pirated products not only being rampant, but also extremely popular with consumers because they are so much cheaper.

Personally, if I were to be objective, I have to say that both supporters and detractors have valid points. But if I were to look at its financial numbers, OSIM currently trades at a hefty 37x rolling PE, which is extremely high for a company which lost $9.8m in its last quarter. Hence, in my opinion, OSIM should have more downside to come.

That said, the market has a way of proving people wrong all the time, so who knows, OSIM might just do an STX Pan Ocean and keep riding high without any fundamentals to back it up. So, if you are holding on to OSIM stock or looking to buy, it might be best to wait for its next set of results before deciding what to do.

But for me, I prefer to use facts to analysis a stock and would only invest in it if the upside far outweighs the downside. For now, OSIM looks as if it could swing as much either way, so I would look elsewhere for now.

Sorry, Ron Sim.

CRCT - how to hop onto the bandwagon?

"The Edge" magazine for the week of Dec 25th - 31st, published an article listing the "Ten Stocks to ride for 2007". CRCT - Capitaretail China Trust - was listed as one of them due to (according to the article) its association with the China theme, a winning combination of yield and growth, and high demand for the stock with its IPO almost 190x oversubscribed.

Thanks to the article's endorsement, its price has rallied some 10%+ from a consolidation level of $1.75 - $1.80 to over $2.00, making an expensive stock even more expensive.

At $2.00, its expected yield payout for 2007 is only a paltry 2.7%, yet CRCT commands such a premium because many believe that with Capitaland as its sponsor, future mall acquisitions would come very easily, thus boosting its value. At the rate the price is rising, it seems as if the consensus is that this stock's growth potential is boundless.

So how does an investor buy a stock like CRCT that keeps rising and rising? I find that the best strategy is buy such stocks is not to wait for it to fall back to your preferred price because it might just never happen. At the same time, I also know that to buy at this level is a little crazy because you just might be caught in a bubble.

To solve this dilemma, I would recommend averaging into the stock instead of buying one chunk all at once. This way, you end up a winner regardless of which direction the price moves. If the price keeps going up, then least you have some of this winning stock. But if the price goes down, then you are able to average down your cost and buy more now. Isn't that a win-win situation?

But when it comes to averaging down, I realise that its quite tricky knowing when to do so. They best way is to buy at the key support/resistance levels, but that requires some knowledge of technical analysis which most people have problems understanding. Even I took almost a year to grasp the basic concepts and I'm still learning. Even then, my brain just does not operate like a technical investor.

So I actually devised a strategy which I found rather useful. I would average down my cost at every price drop of 10-20%. So in this case, if I bought some stock at $2.00, I would perhaps average down at every 25cts drop, i.e. I would buy again at $1.75, $1.50, $1.25, $1.00.....

Of course, I'm not advocating a buy at $2.00. I do understand that this is paying quite a premium for it and I prefer to wait for a buying opportunity and look around elsewhere for the moment. But if you die-die must own CRCT, then this is what you can do.

You can also use this strategy on other great stocks that just keep rising and rising.

Technorati Profile

Eastern Holdings - is it the new Yongnam?

I'm sure anyone who has seen my portfolio would immediately notice Yongnam. After all, this is a stock which grew by 262% in less than three months and made me $64,000 richer (so far). But its meteoric rise has not gone unnoticed, and it has been the hot stock of late, on the minds and mouths of most investors and analysts.

Hence, I don't think I can say anything new about it. So instead, I want to talk about my latest stock buy - Eastern Holdings. Never heard of it? Don't worry, you're not alone. Let me tell you why I think it could very well be the next one-bagger in my portfolio.

Eastern Holdings - here - began in 1981 as a publishing company. Over the years, it established several lifestyle and trade magazines including well known publications such as Motherhood, Teens, GOLF, Motoring, etc.

But in October 2004, it ventured into property development and began purchasing land for development. Currently, it has developed 4 residential properties in the prime district 9 & 10 areas for sale. It also owns and rents out 2 shophouses in Amoy Street, an industrial building in Lower Delta Street, as well as 9 apartment units in Zhuzai, China, for investment.

Currently, Property and construction are the hottest sectors in Singapore. almost all property and construction stocks have risen by 50% or more since September 2006, and most of them trade at 20x 2006 PE or higher.

But guess what, because Eastern is still listed as a publishing stock not a property stock, it currently trades at a ridiculously low 6x 2006 PE. What's more, because it only ventured into property development recently, it has yet to register any profit from it. Publishing still makes up more than 90% of its revenue, which suggests that there is room for a lot more growth from property contribution.

Furthermore, Eastern also paid out a total of 3.2cts in dividend after tax for 2006, which works out to a 13.9% dividend yield at current price. Since I expect its profits to grow significantly, I also expect that the dividend payout will increase.

Because Eastern is a small cap stock, it should be pegged at no more than 15x PE (a discount to the idustry standard 20x PE). Which I why I think Eastern is a great bargain because even if it goes to just 12x PE, it would already have doubled in price!

More about me.

I've received quite a few comments asking me how I managed to have so much money at my age - did I do it myself or did I have any help from my family.

The answer is that I did it myself, but that answer begets another question - how is that achievable?

To answer that I have to bring up my past. All my life I studied at some of the best schools in Singapore. I was in the SAP stream in secondary schools (to non-singaporeans: this means that I studied both english and mandarin as my first languages) and did well enough to go to one of our nation's top Junior Colleges. After completing my JC, I again did well enough to qualify for a place in university. My life and future seemed set: get a degree, get a good job, get married, live happily ever after.

But then I asked myself, is this really the life you want? I asked myself that question for two long years in my National Service before I got the answer: I would not be happy in that safe and comfortable 9-to-5 job because I wanted more out of life, and besides with a salaried job, I would never get as rich as I wanted to be even though there are billions and billions of dollars floating out there in currency.

Once I came to that realisation, my entire life changed. I dropped out of university, and instead of falling back on my education, I chose to go for broke trying to find out what my passion was and to develop money generating businesses and ideas. Of course such unknown territory was tough initially, but I was driven by my stubbornness and fear of failure. But eventually, my perseverance paid off and I slowly started to make some sort of a living.

Today, I'm glad that I've achieved a good measure of success, and I honestly think that this is just the beginning. I hope to do many other things in the future.

That brings me back to the question: so how do you go about earning the big bucks?

First and foremost, I think its important to get out of your comfort zone and think out of the box. You don't get rich by being a follower, and that principle applies both to business ventures and stocks. I cannot emphasise enough how important it is to have first mover advantage.

The second thing is to ask yourself: how badly do you want to be rich, or how badly do you fear not being rich? I'm a firm believer that anything is achievable if we want it bad enough. Just think about this - Have you ever wanted something so badly that you spend every second thinking about it? For most people, it is their first love. Do you remember thinking that you would die without the person, and that you simply can't imagine life without the person.

Imagine if you felt the same way towards getting rich. I guarantee you that even if you don't become a millionaire, you would do very well just because you cannot imagine if that were not the case. If you can have the mindset that life is unimaginable without being rich, trust me, one day, you will succeed.

That is of course, the hard way. No doubt you could also be very lucky and just hit the lottery, but unfortunately I don't have that kind of luck. I have to make my own luck, but I'm glad to say that I think it can be done.

Singapore investing websites.

In the course of reading and and researching on stocks, I often use these websites because their content is more focussed on the Singapore Context.

Canslim Forum:

This is another stock and investing forum, except that it focusses on growth stock investing using the CANSLIM principles created by William O'Neil. The principles are based on the common characteristics shared among the greatest performing stocks. This forum rather successfully implements the CANSLIM principles to SGX-listed stocks. See description on CANSLIM on Investopedia and Wikipedia.

Channelnewsasia Market Forum:

Frankly, good information is rather rare in this forum. Its posts are mostly either full of nonsense or vested interest.

however, I do visit this forum for 2 main purposes -
1) It is good for getting a feel of the small retail investor sentiment for both a particular stock and the overall market.
2) for a contrarian view: whenever a lot of interest is taken in a stock on this forum, it is usually a sign that the stock is overvalued.

Shareowl here is another website I know of that has content in the Singapore context. However, I do not use them since it is a paying site, but you might want to. You can also read financial articles on the Singapore Business Times Online here. Access is free after 8pm daily.

Shareinvestor.

If you intend to spend a lot of time and money on DIY stock investing as I do, I'd highly recommend subscribing to Shareinvestor (please note that I have no vested interest). I was first recommended to it by my broker, when I asked if there was a single comprehensive website that allowed you to track stock prices in real time up to the second, and would also allow you to create a stock portfolio which would update itself with every single price movement. Shareinvestor was the solution.

Besides those two functions, Shareinvestor also allows you to track a total of 5 portfolios of 50 stocks each. I use it to track stocks in the following manner:

1) My personal portfolio + stocks that I'm currently interested in.
2) STI Index stocks + other large cap stocks.
3) Mid cap stocks (Annual revenue above $150m).
4) Small cap stocks (Annual revenue below $150m).
5) China Stocks

Shareinvestor also has an information page on every individual stock, with information on both its fundamental and financial figures, it also has every single technical chart available, as well as links to all other available information on the stock, especially through the SGX website.

It also has a forum on every single stock, in which the paying members can post their comments on the stock. Surprisingly, there is quite a lot of valuable information on the forum as a lot of the shareinvestor members are very experienced investors with years of experience in the stock market, some even decades. I admit that I have picked up a few stock tips from there!

There is even a specific page for IPOs, as well as a forum. Look out for a member named Pahlawan, who is revered in the forum for his accuracy in picking out good IPOs. Unforunately, those of you looking for a detailed and logical analysis will be disappointed. That is not his style. Instead, he terms the IPOs as food rewards like Sharks fin, BKT (Bak Kut Teh), chicken drumstick, or kopi, depending on how much profit you can make out of it. It may seem a little "unscientific", but trust me, if Pahlawan says that an IPO is Sharks fin, you better as hell apply for it!!

What's best is all these Shareinvestor services are available for just $11 monthly - so much info for just the price of a dinner and a movie (and you would have to go by yourself!) - its definitely a bargain to me.

Those nice folks at Shareinvestor are also offering a free one month trial. Do not worry because you will not have to give out your credit card details, so at the end of the one month, the trial will simply expire by itself. It will not continue running and secretly deduct money from from your credit card.

So, what are you waiting for?

My definition of risk.

One of the fundamental ideas in finance is the relationship between risk and return. The common belief is that the greater the amount of risk that an investor is willing to take on, the greater the compensation should be in the form of greater returns. And the reverse is also believed to be true: the lower the risk, the lower the return.

I agree that the statement that riskier assets tend to give higher returns and vice versa is genrally true, and that the common accepted theory today is that the best way to maximise return and minimise risk is to hold a diversified portfolio of investment assets.

However, I believe that diversity is not the only way to manage risk. One can also manage risk through aquired knowledge.

Risk also comes about from not knowing what you are doing, and if an investor would take the time and effortto aquire knowledge about the stock market and individual stocks, to study them, and to monitor them, he will realise that risk is nothing to be afraid of.

He will realise that risk creates market fluctuations, and market fluctuations create opportunity.

Dec 06 - Jan 07 Portfolio.

This is how my stock portfolio currently looks like. Although it currently consists of mainly small cap growth stocks, I would not ignore large caps or value stocks so long as I find them to be undervalued by the market.

I will be discussing some of these stocks soon. Stay tuned.

Disclaimer: Please do not attempt to replicate my stock portfolio or to buy into any of my stock holdings without your own prior due dilligence, as it could result in significant losses.

This blog also reserves the right to sell any of its stock holdings without prior notification to its readers.

Introduction.

Welcome to my blog.

For 2006, I began the year with a stock portfolio valued at around $200,000. As of Friday, 22th December 2006, the value of the portfolio has grown to $355,688. This works out to an absolute profit of $155,688 or a return of 78% for the year to date.

So in this blog, I will be commenting on my investment strategies and ideas, and will also reveal and discuss the stocks which I currently hold in my portfolio, as well as any other stocks that might be worth investing in. I am also a frequent contributor to Sgfunds, which I believe to be Singapore's best investment forum and where I can find many like-minded people with a strong passion for investing.

I want to state that although my profits are extraordinary, my background is nothing special. I never had a finance education, having never ever studied economics nor accounting in school. In fact, I do not even have a university degree. All I had was a belief that investing can be easily learned if you put in the hard work, and if you invest on your own, you can easily do better than investing with those expensive financial institutions and firms.

Thank you for reading, and let's make these extraordinary profits together!