Sunday, 21 July 2013

Buying when no one is looking..

Initiating a position in a counter is not an easy thing. Psychologically, you wonder if the price is low enough to buy, and worry about whether the price will drop further post purchase. Fundamentally, you wonder if your analysis on the company's efficiency and future growth drivers is correct. In short, you are battling a wall of worries before buying.

From a technical perspective, do you purchase when the stock price has risen a lot and firmly in an uptrend? Meaning you join in the fray when the market had taken notice of the stock and bid it up to a high price? Buying now may give you a psychological comfort as you are not alone in feeling positive about the counter's investment merit, but many more other people hold the same view as you. In short, we are in this together! When it is a group activity, you are comforted by the fact that you are going with the crowd, not against the consensus.

However, this is a false sense of security.

As a retail investor, we are usually at the bottom of the information chain when it comes to the latest happenings related to the counter. What we are acknowledging as the crowd reaching a consensus on the company's strength may be a phenomena created by the institutional investors whom have been vested much earlier. This provides them a chance to unload their shares to you, the retail investors. As that is taking place, the strong hands will leave the scene soon after they have finished selling, taking away the buying that props up the price, which will subsequently fall, leaving behind retail investors holding on to the dumped shares. This is invisible hands at play.

Also, even if there are no invisible hands at play, buying when the counter is popular makes that purchase an expensive one. There is no chance to buy at a cheap price. Now, would you rather buy a strong company at high price or low price?

For me, I would prefer to buy a strong company with solid fundamentals, when no one is buying, or even aware of the counter. This allows me to buy slowly and relaxed-ly, at reasonable price. Post purchase, I will put the counter into my safety box, only to be examined once a week on any industrial landscape news, and once a quarter during the reporting season.

I maintain my conviction towards the strength of the company, based on thorough fundamental analysis, and a deliberate act of not looking at the day-to-day fluctuations in the counter's price. This enables me to remain objective and relaxed, further reinforcing my conviction. I will wait patiently for the market to take note of the company, and wake up to its strength. When the mass market join in the fray creating a  buying spree, that is when I will slowly sell the shares to them, taking profits off the table and leaving the scene to search for the next solid cold stock.

One example of my 'cold stock' purchase using this method is Riverstone Holdings.

I will not go into the background of the company, you may just google it and have a good read on its business and operations.

Some of the key plus points of Riverstone are as follow:
-increasing revenue over the past 7 years (~15%)
-increasing net earnings over the past 7 years (~10%)
-positive net cashflow from operations over the past 7 years, concurrently displaying positive growth
-positive free cashflow over the past 7 years
-in a net cash position
-consistent ROE above 15% over past 5 years
-consistent ROA above 12% over past 5 years
-consistent and increasing dividend payments over past 7 years
-consistent dividend payout ratio of ~50% for the past 5 years
-consistent dividend yield around 5% past 3 years
-the founder and president hold a large stakes in the company (>50%)
-the management displayed clear strategy in opening up a new market for its products
-the management had foresight and vision to expand the production capacity to cater to future growth, without tapping on rights issue or taking up more debts

These are all attractive characteristics of the company. However, the company is a cold stock. It has minimal analyst coverage (I think 1 or 2); it's trading volume is low; it has been consolidating within a tight price range; it garners little discussion on forum; it does not appear on Business Times or The Edge.

So, I went in, made a purchase, keep it in my safe, monitored the quarterly report, and maintained my conviction while remained unfazed at the subsequent price drop (~10%).

Now, the share price has risen by about 25% in a span of half a year. Not too shabby for an investment I must say. It feels all the more satisfying that I had stuck with my strategy and remained entrenched in my belief, and finally proven correct.

Some of you may ask: 'what if the share price plunge tomorrow?', 'what if you had to wait for 5 years?', 'what if you analysis is wrong?'

Well, to me, I have done my due diligence and homework. If the company fundamentals consistently improve as per what my analysis told me, I will continue holding it, believing one day the cold stock will gain public's attention. If the price fall tomorrow, that is a short term change in the market dynamics which does not perturb me as a fundamental investor. The company is still doing well, still generating healthy cashflow, giving out generous dividends. As for how long do I have to wait, this is the biggest uncertainty that is beyond everyone's control. It could have been a 5 year wait instead of a 6 month wait. Market may be sleeping or taking its own sweet time to wake up to the company's attractiveness. This is something I have absolutely no control over and will not worry over it. However, granted that the fundamentals keep improving, I will still set a maximum time of 3 years, before deciding to cash out.

Here you have it, a summary of my purchasing solid cold stock strategy. Nothing new, nothing special. However, the patience, the conviction, and the thorough homework are crucial to the execution of such strategy.

I will continue my hunt for solid cold stock, bearing in mind the mantra: buy strong company when no one is looking..

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