Thursday, 15 October 2015

Investment: Art Or Science?

I believe that investment is a combination of art and science, more of an art.

It's definitely not a straight forward science.

I know that I'm not a knowledgeable investor.

I'm also not a good learner.

Though I use fundamental analysis in stock market investment, my fundamental knowledge is actually very shallow until today.

What I know is something very simple which everyone else knows, PE ratio, ROE, Debt/Equity ratio, dividend yield, EPS growth etc.

So, I'm not a "special one", I'm just a " normal one" :)

I know the importance of some other more accurate financial ratios such as ROIC, Enterprise value, certain cash flow ratios etc but I rarely use them.

I read from books and numerous articles about the importance of intrinsic value and margin of safety in investment but I didn't really apply them.

I did try to learn to calculate fair value of stocks using dividend discount model and discounted cash flow model. 

However, when I realize how the fair values are derived, I straight away gave up. This is because the calculation is based on lots of assumption.

Please don't get me wrong. I don't mean that intrinsic value calculation with DDM and DCF model do not work.

Actually they have been proven to be useful and important in value investing throughout the world.

Some may think that I am too "cocky" to ignore all those proven investment methods and do it all my way. It's OK. I'm not that great as most of you think.

Everyone has their own investment style and I'm applying what suits me the most at this point of time.

So far I really find it difficult to put DCF into my brain.

My investment style changes with time. There have been quite a lot of changes throughout these years.

I notice that there is some small but significant changes this year. Has anyone notice that I seldom talk about things like ROE, EPS growth, DY recently?

For me, stock market investment is a game of prediction. I predict the growth, the strength and the sustainability of a business. 

As most of the time I plan for longer term investment, a sustainable business in mid to long term is important.

Growth - can the sales and profit improve?
Strength - is the company competitive? can it survive a downfall?
Sustainability - can the business and the company last long?

As fundamental investors, we all try to make an intelligent guess on a company's future, or the share price movement for those speculators.

While I'm not calculating intrinsic value with DCF/DDM method, I'm actually still looking into the company's cash flow, as well as balance sheet when choosing a company for investment.

If the company has lousy balance sheet with high debts and low quality assets, how can it survive a downfall or last long?

If the company has poor cash flow especially poor free cash flow, how good a balance sheet can it has and how long can it last?

If the company has poor ROE, has high debts but it gives signs of growth and its cash flow is improving (like Hevea some time ago), it is still a good candidate for investment.

So it's not necessary to get the ROE box ticked before putting my money in a company.

It is not easy to find a perfect company that tick all the boxes.

If there is, its share price should be imperfect.

The "margin of safety" I'm using is PE ratio. If I want to be safer, I will use lower PE ratio as an entry point.

Anyway, PE ratio is not flawless of course. Just look at most property stocks' PE ratio at the moment.

I don't have a formula to pick a stock for investment. It is all based on the "right feel".

That's why investment is more of an art for me.

People are like this, we are scientific people and we want to have everything in order and make everything more simple.

So we come up with various magic formulas in investment.

This makes investment more like a science rather than an art, if you follow the formulas rigidly.

Again, I'm not saying that these formulas are useless. Certainly they have helped many investors to make good and correct decisions in investment.

I cannot rule out that I will use these formulas or calculate intrinsic value in the future.

Everyone has their own opinions and investment styles.

There is no need to condemn others if their views are different from ours.


  1. Well said BD, another great article about investment.
    I'm agree with you the 3 points :Growth,Strength and Sustainability of a company. Always think as an entrepreneur when come to invest.

  2. Another excellent article describing your investment journey !
    I can relate to your points above because I also have gone through some of them.
    I attended course teaching ROIC, enterprise value and DCF & etc before. There was a time I relied too much on those scientific methods and later found out there are flaws in each of them. For example :
    *High ROIC may mean the company keeps too much cash and don't utilise it fully.
    *-ve enterprise value stock may have reason for it's depressed stock price and the price may remain low for long time if no catalyst to "awaken" it.
    * DCF needs 5 years or 10 years and terminal growth rate as input for calculation. If the "predicted" growth rate is wrong, the intrinsic value calculated would be mis-leading. Imagine how difficult it is to predict the growth rate in so many years to come accurately.
    As u mentioned, it is not the scientific methods don't work, but not sufficient to work.

    I was also too "rigid" on ROE before and refused to invest in company with single digit ROE. The result was I lost several good opportunities.

    At recent stage, I try adopting your method, which is to understand the company's business by reading the annual & quarterly report as well as other news related to the company, and then using the knowledge to predict the subsequent quarters' EPS, and then assign a reasonable PE to it and finally calculate the fair value. You know what ? it works well for me and I am going to follow this path :)

    I strongly agree with you that stock investment is a prediction game. The more we understand a business, the better chance we can predict it's subsequent quarters' earning.
    It is very possible to predict next quarter's earning if compare to predicting the growth rate in next 5 or 10 years as in DCF calculation.

    I think the "art" portion in stock investment needs experience to nurture. It is harder to pick up if compare to scientific methods. If we have experience in running a real business, I believe that would be an advantage to equip ourselves in the "art" of stock investment.
    Since I don't have the business experience, I suppose I have to try to think like a business man then.

    Lastly, I only don't agree with one thing in your article above.
    I don't agree that you claimed yourself as a normal one. I think you are outstanding.

    1. Thanks for viewing me so highly, and thanks for going in length to share your investment journey and opinion here.

      "It is very possible to predict next quarter's earning if compare to predicting the growth rate in next 5 or 10 years as in DCF calculation." - This should be the main reason why I'm still not keen to use DCF.

  3. Hi BD, I have a question in my mind and would like to seek your opinion.
    I define the businesses in following manner :
    a) Tier 1 business - this is OEM manufacturer, eg. Avago
    b) Tier 2 business - this is business providing EMS service, eg. Inari
    c) Tier 3 business - this is the vendor to OEM or EMS, eg. KESM, who perform burn-in service for semi-conductor manufacturer
    d) Supporting business - they sell machine/tester or automation to manufacturer, eg. Elsoft, Pentamaster.

    From your past articles, I suppose you would prefer tier 1 and tier 2 businesses, but dislike tier 3 and supporting businesses, do I interpret correctly ? If yes, can I ask what is the reason behind for your preference ?
    The reason I can think of is when that industry is booming, tier 1/2 business will be the first ones reaping benefits. When the industry is bust, tier1/2 business would cut spending and tier3 & supporting business will feel the pain most. Besides, tier1/2 businesses may have more price bargaining power.

    1. I don't classify business like that but your classification above really make a lot of sense. I don't quite like those testing, automation solution, software provider kind of business mainly due to personal preference.

      I would love to be part of Tier 1 business and may be above Tier 1 like Apple/Samsung which command a brand power. However, Tier 2/3 is usually smaller companies which may possess higher growth potential. In the end, any company with good future and selling at undervalued or reasonable price is good for me :)

  4. PE is still very useful, but have to compare with the same industry I think

    1. yea, it's still my most important criteria before buying in a company's shares.

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  6. I don't see anything wrong with your method, BD. But the example that you're giving, Hevea. I believe it depends which type of investor you. And how do you want your portfolio looks like.
    As saying goes "focus on the downside, and let the upside takes care of itself".
    #If the company has poor ROE, has high debts but it gives signs of growth and its cash flow is improving (like Hevea some time ago), it is still a good candidate for investment.#
    I do not disagree this could be a good investment but I think you may agree also that there're certain risk for this investment(and it is higher than others with lower debt and better cash flow).

    If i were a medium risk taker, yes, Hevea would be my selection. If i am a low risk taker, I would probably say NO to Hevea

    Ones could only earn BIG if he/she is a contrarian. And only someone who has a lot of faith in that company would able to do so.

    Did you buy more when hevea dropped to 70cents++ two months ago? :)


    1. BTW, you're a good FA investor. At least from bottom of my heart, you are :)

    2. Thanks hissyu2.

      Case like Hevea is always tricky. If no luck, it might go against us. I started to study Hevea when it was around RM1.40, and I decided at that time not to invest in it. I think the risk is higher and I doubt the sustainability of its sales & profits.

      Later when I felt that its financial results are sustainable, its share price already went up a lot above RM2. This has again prevented me from invest in Hevea. But after that, I think this company is too "robust" and I finally bought at RM3.10... I still plan to add more actually.

    3. Yes. So, it depends on the risk appetite that you have. Hevea at 3.1 was still a good bet :) Only invest when we're comfortable, else you have to monitor the share price daily, don't you?

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