The Definitive Guide: How to Start SG Stocks Investing [Part-4]
“How I Make 50% gain in 2 months using this step-by-step value investing strategy!”
“Stock XYZ increased by 250% in 10 month”
I believe it’s not hard to see some of these claims reported in investment course advertisements…
… And you might wondering how true is that, or worst you believe that can happen to you.
I will explain to you on the below.
On my previous series, one of the areas that I covered was investment return and some of you might have some reservation as those returns are not what you normally have heard or seen in many claims.
So I thought to address some of the questions that you might have. I’ll assume that all those claims are authentic if not that will just be an outright scam.
Even so, you still need to aware that reporting has its own form of bias, and it’s better to always view investment returns and testimonial with a healthy skepticism rather than taking what you are being told.
#1 – Individual stock performance bias i.e XYZ stock rise by 100% in 3 months!
A very common reporting bias indicating attractive investment return on a stock or list of a few stock showing their outstanding stock picking skill or investing strategy.
One has to understand that those investors do not hold a stock or a few stock, their holding might be 30–50 stocks on their portfolio. And hence, having a few stocks that perform really well in the short period is nothing to be amazed of.
It’s simply reporting the rise of a few outstanding performance of stocks on a portfolio.
Investors should always measure investment return on total returns(div + cap), and on a portfolio basis.
This is where the number becomes conservative like what we see on STI ETF 7% CAGR, successful assets management fund 10–15% CAGR or Warrent Buffett of 19% CAGR.
#2 – Testimonial bias on investment returns i.e Tom made 50% in 3 months using XYZ strategy.
All course providers and strategy have probably been taught by over thousand of students. Just think about it how hard could it be to pull out the 1% that perform really well? This has nothing to do with investing/trading strategy, it’s just a big number game and it works by probability.
So if you are wondering whether the investing/trading strategy works the same as they described? Probably yes, but you need to aware of this large number bias.
#3 – Outstanding “Trading” track record i.e achieving a 14 months winning streak
You might find it hard to accept until you have read the book Fool by randomness or Black Swan by Nassim Nicholas Taleb. Track record and consistency don’t mean much when it comes to trading as it’s in a highly unpredictable volatile financial market.
A trader can consistently be profiting five figure monthly for a year or two, and yet still been wiped out in a few weeks is not something unheard of. And just because it didn’t happen in past few years it does not mean it won’t happen in the upcoming years.
The high exposure of a black swan event(low occurrence but highly impactful) on traders in the financial market makes their trading record very vulnerable.
#4 – Hedge Fund, asset management fund and etc i.e XYZ firm grows its AUM(Asset under management, the money they managed) of $60M to $500M in 5 years.
I got this from one of the readers asking how does the investing firm achieves such a high investment return as that would translate to 52.81% CAGR!
The answer is, the growth of AUM has nothing to do with their investment performance. They are just simply stating that they have grown their AUM that could be due to investment gain and/or attracted new capital because of their outstanding performance.
And, the reason is highly to be they have attracted new capital.
Interested to know their investment return? Then head over to their performance section to check their CAGR.
What Makes The Market Prices Go Up Or Down?
The plan and simple answer is supply and demand.
When the demand of stocks exceeds the supply, the price will go up. And, the opposite of demand less than supply, the stock price would go down.
This same concept applies to every commodity and product, and not just stock prices alone. In a market there are buyers and sellers, demand is represented by the buyers, and supply is represented by the sellers.
As a buyer like ourselves we always hope to buy something cheap or pay low, where else for a seller for example like selling our second items in Carousell, we always hope to sell at the highest price as possible.
So there’s always a tug of war going on between buyers and sellers in a market.
Demand(buyers) > supply(sellers) = Prices go up
Demand(buyers) < supply(sellers) = Prices go down
In the case of a stock market it works the same, investors who want to buy the stocks believe that the stock price is low(expecting price to rise), and the investors who wanting to sell believe that the stock price is high(expecting price to drop).
The stock price will go up when there are more buyers than the sellers, and the stock price would go down when there are more sellers than the buyers.
Note: The term “market” is normally referred to a stock exchange, however in many situations it also means the expectation of collective individuals such as buyers and sellers.For example the market move up by 10%, which means the price has been transacted by 10% higher, buyers are paying 10% more, or seller has sold the stocks by 10% higher.
In the short-term the market is driven by sentiment and emotion, and whichever side is the strongest it will be the winners at the end of the day, I’ll explain it though market ladder on the below for better understanding. However, on a long term it will be driven by fundamental.
So what causes investors to want to buy or sell?
Usually, the news and expectation.
When the company outperform its earnings expectation the stock price will rise.
When the company unexpectedly wins a lawsuit the share price will rise and when the company being accused of having fraudulent activity the share price will drop as no one wants to hold an ownership of a fraudulent company or perceived to be fraudulent.
When the sentiment of the market is positive for over a period of time it will be referred as the ”bull run”, “bull market” or investors are say to have a “bullish view”, where else on the opposite it will be referred “bear market” or “bearish view”.
By now you should have noticed, on every stock transactions there will always be a seller and a buyer. No transaction can be made in the absence of one party. You can’t buy something when no one is selling it and, of course you can always attempt to make a higher bid to entices sellers to sell, but only if the sellers are willing to take the bid, otherwise the transaction will still not happen.
Bid vs Offer – which is which?
Ah.. I have the same confusion in the start as well, the little memory trick you can use is looking at the first alphabet of bid and buy both are “b”. Hence, the other one must be a sell.
When We Say Market Price, Which Price Are We Referring To?
Since there is opening price, closing price, bid price, offer price and market price. So which price are we exactly referring to?
The answer is the last transacted price or also known as the last done price.
The opening price of today market was the closing price of the yesterday market. And in between the day the price is determined by the last transacted price.
So if the last transacted price happens to be in the bid then the bid is the market price, and the same for offer.
Continue reading the below for better understanding…
Market Ladder(aka Market Depth)
I think the best way to visualize how market price changes from the interaction between buyers and sellers is to bring out the market ladder.
The below is what you normally see on the web/TV
This only shows two prices.
The best bid(buy) which is 3.910 and the best offer(sell) which is 3.950.
But what’s really happening on the inside may look something like this…
This is what the actual market look like on the inside, don’t worry if it looks confusing at first, I first came across it during my prop trading days, and happened to know that even seasoned traders might not have seen this before. Study the ladder carefully as it helps in the understanding of how prices move.
As you can see, there will be a list of bid and offer prices and with the order’s volume showing beside each of the prices. That blank in between is known as spread (explained below).
So for the price of $3.91 there are 6,000 bid orders, and 8000 offers on the price of $3.95, 10,000 offers on $3.96 and etc.
If I want to buy 1,000 shares, I can either go for the market price which is the best offer at $3.95 which I will get my order filled immediately as there are 8,000 offers at the price of $3.95 waiting to be filled. This is known as “lifting the offer” or “market order.”
Or I can place 1,000 bids at $3.94. However, this method does not guarantee my order will be filled as there is no offer on that price. It will show as follow
The 1,000 bid orders will be remained as it is until either I cancelled my orders or the sellers filled it by selling his share at $3.94. This is also known as “hitting the bid” or “market order”
Investor A wanting to buy 5,000 shares at the price of 3.91 and 5,000 shares on 3.90, the ladder will look like this after the orders are placed
Do note that by placing the bids it does not mean the Investor A has bought the share.
Investor A orders must be filled meaning someone the sellers must be willing to sell his share at price $3.91, even so that seller must sell 11,000 shares.
The first 5,000 shares sold by the seller will be filling the first 6,000 orders which are the existing bids.
The balance of 6,000 shares will then be filled on the Investor A orders. In short, when we put up a bid we will have to wait for the order to be filled. The same applies to the 5,000 bids that placed on the price of $3.90.
What would Happens if 300,000 Selling Market Orders Come In?
If that happens, those bids on each price i.e 3.9, 3.89, 3.88, 3.87 and 3.86 will be taken up one by one until the 300,000 market orders have been fully filled.
And on the above example, the price will drop from $3.91 to $3.86.
And when the selling pressure is strong, those orders that placed on $3.95 and above will start to move down as they might not get their order filled when the last transacted price is so far away at $3.86.
What is spread?
A spread like this occurs when both sides, the buyers and the sellers none of them want to compromise their price.
For example, the buyers do not want to buy at $3.92, $3.93 or even $3.94.
And of course, neither do the sellers wish to sell at $3.92, $3.93 and $3.94.
Hence, there are NO orders have been placed at those price levels.
Or the other way to look at it is that the market might not have sufficient buyers and sellers to make the transaction as freely as possible.(Not on my above example, as there are huge order volume)
In financial term this is called lack of liquidity. For more info click here.
After showing you the market ladder, I hope you will have a better understanding on how the price changes in the price quote as compared to just looking at the single line best bid and offer that show on your chart or TV which it really doesn’t tell us much.
In this section, I’ll be covering the basics ratios and metrics that you normally see on an chart overview, not everything will be covered if there are things that you need more information then Google search it.
Basic fundamental raito — Price to a “fundamental”
On the general level, Most of these metrics are in the form of price to a “fundamental”. The denominator representing the valuation dollar you would get by paying the market price(stock price per share).
For a price to earnings of 3x, it means are paying $3 for $1 of its earnings. The denominator is always $1.
For a price to book of 1.2, it means you are paying $1.2 for every $1 of the stock book value.
For a price to free cash flow of 15, it mean you are paying $15 for every $1 of the free cash flow generated by the company.
That fundamental which is the denominator can be in : earnings, net assets value, free cash flow, revenue, cash and others.
Price to Book (P/B)
The meaning of book is referring to “book value”, “net assets value(NAV)” and “equity”. They are all referring to the same thing. Book value is also a theorically value on how much a company is worth after deducting all of its liabilities.
How does book value derived?
Total assets - Total liabilities = Book value / Net Assets Value(NAV) or PtB
Total assets $850M - Total liabilities $500M = NAV $350M
NAV $350M / 100M outstanding shares = NAV $3.50 per share
If the market price is trading at $4, then that will be $4/$3.5 = 1.14.
The Price to Book or P/B will be 1.14.
So for every $1 of NAV the market is valuing at $1.14. Or you can treat it as you are buying the stock for $1.14 for every $1 of the stock’s NAV.
When the P/B is more than 1(the example) it suggests that the market is valuing it at a premium, as the investors are getting less than what they would pay for the net assets of the business.
However, it does not mean that it is a bad deal, but rather it could be the market believes that the NAV of the business will rise in future. Hence, it makes investment sense for investors to pay more now.
On the other hands, when the P/B is trading below 1 it means that the market is valuing the stock at a discount. This can be viewed as the market believes the NAV is overvalued. Hence, it should be trading at a discount which implies the market is expecting the NAV to drop in future.
Or it could also mean that the earnings of the company are very poor. Hence, the NAV of the stock doesn’t deserve to be fairly priced.
P/B allows investors to have a very quick snapshot as to whether the stock is under or over valued, this is also the ratio that I looked at the most when screening for stock ideas.
However, PtB has its own shortcoming that you need to recognize
- It does not tell you the quality of the assets. The assets might make up of 80% of non-tangible assets such as brand name.
- It does not tell you the level of debt the company has. As it only shows that the total assets are more than the total liabilities, and whether the market is trading its price above or below the NAV.
- It does not tell you anything of the company earnings as to whether is it on profit or loss. And of course it does not tell you anything on its business model and industry
For more info about P/B click here
Price to Earnings (P/E)
P/E gives you a snapshot as to how much you are paying or the market is valuing for $1 of the stock earnings. Or how many years would you be able to recover your investing cost should all things being equal.
How Do Earnings Derived?
On its simplest form, it looks like the above(in actual, may have more items).
It started from revenue, then after deducting all the expenses you will get the earnings. But these earnings are the total earnings that generated by the company, so you have to divide the earnings by the number of outstanding shares to get Earnings Per Share.
And P/E is simply [ Price per share / Earnings per share ]
If the PE is 10 that means you are buying or the market is valuing the company at $10 for every $1 of earnings made by the company.
It can also mean that should every variable remains constant, it will take 10 years to recover back the price you paid for the stock. As each financial year the company reports an earnings per share of $1.
High PE suggests a high expectation of the company to make higher earnings in future. Hence, investors are willing to pay more.
Remember as mentioned on the above as a buyer we always want to pay less so the reason why would people want to pay for high PE is because either they believe the earnings growth potential is huge or the market doesn’t value its current earnings correctly, in other words, the PE is low.
The opposite applies to low P/E stocks as well, which suggests the market has a low expectation on the growth of the stock’s earnings. Or believe that the current earnings are high and expect it to be lower in future. Therefore, it deserves a low PE.
One thing to note on the earnings is that it’s always based on 12 months period. So the earnings figure are either from yearly annual report or past four quarter financial statement.
The flip side of P/E ratio
- Earnings are an accounting number, it does not represent the actual cash flow of the company. Hence, prone to easy manipulation.
- The Price on the P/E equation does not factor in the amount of cash and debt the company has when valuing the company’s earnings.
- P/E does not take into the consideration of company nets assets.
- Company that are making a loss does not have P/E, normally it will show as a blank.
For me individually, P/E has always been one of the criteria that I used for stock screening, you may refer to my older posts for more information.
Stock market valuation
As for the general stock market valuation. The P/E of STI has often been used to compare with its historical average to determine as to whether the stock market in general, is over or undervalued.
For more info on P/E click here
P/E and P/B are two of the most commonly used metrics in investing and can be found in most chart overview, and intuitively it gives us an idea whether the stocks are over or undervalued.
I will stop at here for now, and continue the remaining ratios in the next series…
I know it’s a bit random, I have included the below explaining the T3 cash settlement. All the chapters you see in this guide will be rearranged and re-edited when I completed.
T3 For Cash Payment.
As on my previous part-3 series, where I explained about cash account in which the investors acquire shares by paying cash to the brokerage firm rather than borrowing money(margin account).
One thing I did not mention was that even though you are buying the stocks on cash, the brokerage would not deduct(settle) the balance from your account immediately.
As there is a T3 holding period before the settlement occurs, which means if you bought the share for the total cost of $3,000, it will only deduct the balance from your security at time period of 3 day.
What is T3? It means a time period of 3.
T0 = The end of today cut-off date
T1 = The end of tomorrow cut-off date.
So if today is Monday, T3 would be the end of Thursday cut-off date. It is not that hard to understand this T3 thing so long you remember that it always start with T0 which is the end of today.
Alright, that is all for today. Thanks for taking the time to read and follow my blog.
Hope you enjoy reading it and have learnt something out of it.
I’ll continue the rest of the ratios in next series.
Until now I have yet to talk about any investing strategy as most of my previous series are rather theory and I’m aware of that.
Probably on the next series I’ll start sharing some investing strategies so to give you some rough ideas on how you can construct your own stock portfolio…
So stay tune!