Wednesday, July 23, 2008

Bull's Eye Investing

Recently, Mr Cho (曹仁超) of Hong Kong Economic Journal (信報) - a highly respected investor in Hong Kong - has highly recommended Bull's Eye Investing Strategy as the right investment strategy for the present and coming stock market which should be more appropriate that the long adopted Buy-and-Hold strategy.

The Bull's Eye Investing Strategy was proposed by John Mauldin in his book "Bull's Eye Investing - Targeting Real Returns in a Smoke and Mirrors Market" published in 2004. In his book, he has illustrated a lot of statistics from differnt aspects to suggest that the coming 20 or more years will be a secular bear market. In this period, the performance of stock market will be similar to the period of Dow Jones performance from 1964 to 1981 within which the Dow Jones Index just moved within a range and posed a gain of around one-tenth of 1 percent though the GDP actually grew 373 percent. Therefore, he has pointed out that investors should focus on absolute return instead of relative return and adopted the Bull's Eye Investing Strategy.

Then what exactly Bull's Eye Investing Strategy is? In page 262 of his book, John has summarized this strategy with a few words as below :

"The essence of Bull's Eye Investing is quite simple. Target your investments to where the market is going, not to where it has been. Steady, stable, sure. Buying something that is undervalued, perhaps grossly undervalued, and waiting for the value to be seen by others is the way to real returns. Buying what everyone else is buying, after it has already risen in value, is why most investors simply do poorly"

To me, Bull's Eye Investing is simply another form of value investing. The key is still buy something which is undervalued. However, should we stick with the Buy-and-Hold strategy? In this issue, I have a different view from Mr Cho with the following reasons :

1. John's book is mainly focused on US stock market for which the future performance will be different from Hong Kong and China stock market. Even John himself also suggested investors to diversify their investments in other market other that US market. To me, the future of Hong Kong stock market should be on the Chinese enterprises which have a bright future of development. The China enconomy is now similar to the Hong Kong enconomy in the 70's and great development and change is expected to come. Buy-and-Hold strategy will be very suitable for this kind of market. We have already had many examples in Hong Kong that even a general citizen can accumulate huge amount of wealth from 70's up to now with this strategy.

2. Value investing is more focused on selecting the right company to invest. As Warren Buffet has said, you should treat yourself as one of the owner when you buy the shares of a company and prosper together with its future development. Simply focus on overall performance of stock market is not the key to value investment. Buy-and-Hold also does not mean you buy the stock and hold it. You have to do your own analysis and buy the stock when it is undervalued. Therefore Buy-and Hold strategy should still be the right strategy for value investing in any form of market.


Thursday, July 17, 2008

Hong Kong Stock Market - From A PE Perspective

Traditionally, PE ratio is a useful measure of the valuation of a company. Recently investors have been diverted to other means of measures such as PEG, PB ratio and ROA etc such that the high valuation of stocks in the past few years can be explained in a more reasonable manner. However, the importance of PE in evaluating the stock market should not be ignored. PE ratio gives the meaning of the number of years you can earn back your investment (the price you paid) given that the earning does not change for the given years. In reverse, the PE gives the earning yield such that investors can compare the yield with other type of investments to see if such investment is worth.

How is the application of PE in evaluating Hong Kong stock market? I have plotted a graph of monthly PE of Hang Seng Index (a widely adopted indicative index for Hong Kong stock market) for the period of Jun 1974 ~ Jun 2008 which is shown at the top of this blog. From the above graph and data, I have the following findings which may be useful in formulating investment strategy for Hong Kong stock market :

a. The average PE over the period is 14.58 with a Standard Deviation of 3.6. This means 68.27% of the data points lies within PE ratio from 10.98 to 18.18 (1 SD). 90% of data points lie within PE ratio from 8.68 to 20.48 (1.645 SD). This gives us a hint that whenever the monthly PE of HSI goes beyond 20.48, it is more likely that the market is overvalued and there is 90% chance the market will turn downwards. This is the moment of last tango. For those monthly PE of HSI goes below 8.68, it will be a real bargain to buy.

b. The lowest of point of PE for each high-low cycle is becoming higher and higher which means the market is willing to accept a higher PE for HSI in the recent years which may be explained as more and more Chinese enterprises were selected as components of HSI which are mainly growth stocks and investors may be more willing to buy at a higher PE.

c. From a simple glance of the graph, I would rather start buying at around PE ratio of 10 for which the risk has been significantly reduced.

In conclusion, I will suggest investors to buy when HSI dips below PE ratio of 10 and avoid stocks when HSI goes up above PE ratio of 20.5.

As a reference for today (17th July 2008), HSI close at 21735 with a PE ratio of 13.19 which is below the mean by 1.39.