Tuesday, June 17, 2014

Narrowing Down the Investment Universe

While I was earlier browsing the net looking for examples of Singaporean personal finance bloggers regarding their updates to their portfolios and networth, I accidentally stumbled upon this blog called, Mad Stranger the Investor.

Most interestingly I found his post on ranking Singapore REITs based on some criteria. More info on his ranking and scoring system can be found in another post here.

You should definitely check it out to see how he does his REITs valuation, I think this is a great way of putting sound investment theories into a structured framework. Lower P/B is going for value. Higher yield does the same thing as well, since higher yield for REITs is usually indicative of a lower price. Gearing represents risks involved, since they are liabilities and the more a company takes up, the more risk the company has.

My gripe is that his scoring system is based on absolute and arbitrary numbers. Absolute because they are hard and fast numbers, rather than something like a quartile or quintile ranking. Arbituary because increasing gearing from 29% to 31% doesn't increase risk two-fold (scoring drops from 2 to 1). The Mad Stranger must be very careful to constantly remind himself that his scoring system is an rough ordinal one, and not an interval one. Gearing of 0% and 19% also makes quite a substantial difference which is not accounted for. Of course, for simplicity sake, I can understand why he has not made a distinction for that.

I don't think that his framework is perfect, because nothing is. I can see how things could be improved, sure. That still does not discount his work, I think it is fantastic that someone else also has sat down and formulated a thought process and framework to remove emotional bias from decision making. I am confident that his process and ranking system will beat anyone just randomly throwing darts at REITs, which is what I feel many investors out there are doing.

This post by Dr Wealth is also interesting. This is a graph of the performance of the STI compared to different portfolios.

What does it mean? Well, simply put, direct valuation metrics of P/E or P/E is a better indication of value than dividend yield. Although dividend yield is a very good yardstick, Meb Faber has accurately researched and shown that it is shareholder yield that is much more important. With bad enough corporate governance, a company can pay a high dividend, but still erode shareholder yield by diluting shares and taking up debt. Dividend yields is a good quick indicator, but it is definitely by far not the best one.

This article just served to remind me that dividend yield should not be the most important factor, which I always feel that too many people get blindsided by.

Funny as the world is, The Aleph Blog immediately posted an post after I just posted mine, so I'm adding in his post. He exactly talked about just what I talked about, which is blindly chasing yield and the drawbacks of using yield as the ultimate measure. However, it is his final conclusion that is something different which I shall have to think about and read more books on:
Do not rely on stocks for income.  Bonds are designed for income and return of principal.  Stocks are designed for gains or losses depending upon the underlying business performance.  They aren’t income vehicles, but performance vehicles.
Very interesting. Definitely will make me take another look at how I identify stocks.

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