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2019 has gone by in a blink of an eye. It has been a tumultuous year in the market, filled with the uncertainties of geopolitical events such as the U.S.-China trade war, the UK (still) leaving the EU, and the now-withdrawn extradition bill that sparked months of unrest in Hong Kong. These events caused some investors to sell off, waiting on the sidelines for a golden opportunity to re-enter the market at a better price.
As a result of that, those investors missed out on a good year, especially in the U.S. In 2019, the S&P 500 has a year-to-date return of 28.58%:
Which brings us to some key lessons we can takeaway from the year that just passed.
Earlier in the year, investors expected the U.S. economy to slow down as a result of the trade war tariffs. Companies were expected to pass down the higher costs to consumers in the form of higher prices, which would have lowered consumer spending, thus causing a recession.
However, that narrative did not fully play out as anticipated. Companies like Costco mitigated the impact of tariffs by procuring fewer products from China and more from places like Vietnam and Indonesia. They also absorbed the costs on certain items and passed down costs to consumers on products that are more price inelastic. According to CFO Richard Galanti on Costco’s Q1 2020 earnings call: ‘The fact that in some cases where the price has gone up and we have passed on all or some of it, we haven’t seen an impact to the unit sales.’
Although the trade war affected certain industries more than others, the stock market overall did well this year, bolstered by the three rate cuts in the second half of the year that pushed the U.S. market to record highs.
This is far from the doomsday scenario we were waiting for and it’s a good example of what it means to not be able to always predict the market.
Since we’re unable to time where the market is going, it makes sense to focus on the long-term returns of a business. Ask yourself:
The more uncertain you are about a company, the wider the margin of safety you want to factor into your buy price. If the company grows slower than expected, maybe you’ll get a 10-12% return. If it does better than expected, you could get a 15-18% return. Either way, you’re protecting your downside if you allow yourself a margin of safety.
This is basically the thought process behind prudent, long-term investors. Sometimes, you wonder why Warren Buffett invested in Amazon this year despite also saying that ‘prices are sky-high’ in the current market. That’s because he knows that he cannot predict the market. But he knows, based on his valuation of Amazon, the tech giant is likely to generate market beating returns over the next decade.
Knowing that long-term returns are what we seek, we need to then look for quality businesses instead of cheap ones. Here’s one of our learning lessons:
In early 2018, Malaysian REITs were heavily beaten down due to the hike in the overnight policy rate by Bank Negara which would cause borrowing costs to rise. The market often overreacts to bad news and REITs are no exception.
We knew that it was time to look at Malaysian REITs as a few of them were trading at attractive valuations, specifically CapitaLand Malaysia Mall Trust (CMMT) and Pavilion REIT. However, between the two, we make a mistake investing in the former simply because it was cheap.
CMMT owns a small number of shopping malls in Malaysia: Gurney Plaza in Penang, East Coast Mall in Kuantan, Tropicana City Mall, and Sungei Wang in Kuala Lumpur. Apart from Gurney Plaza and East Coast Mall — which have done relatively well and contributes around 60% of total net property income — CMMT has been struggling to turn around the performance for the rest of its assets. For example, Sungei Wang is located along the prime Bukit Bintang shopping belt in Kuala Lumpur and was very popular among locals and tourists during its heyday but has struggled as more and more people now shop for clothes and fashion online.
On the other hand, Pavilion Mall, which is a short walking distance from Sungei Wang, is a premiere shopping mall in Kuala Lumpur which has continued stay up-to-date and attract shoppers despite the growth of e-commerce. Whenever we fly into Kuala Lumpur and visit Bukit Bintang, we also noticed that we’d pop into Pavilion Mall but not Sungei Wang. Even Francis Yeoh, the chairman of Starhill Global REIT that owns the competing Starhill Gallery (located opposite Pavilion Mall) has spoken highly of Pavilion Mall in past AGMs we attended. Sungei Wang, despite its prime location, is just unable to compete with Pavilion Mall in terms of retail selections and offerings to shoppers. And as you may have guessed, Pavilion REIT owns Pavillion Mall which contributes over 91% of total net property income to the REIT.
At that time, CMMT was trading at a 20% discount to its net asset value and yielding 7.8%. In comparison, Pavilion REIT was trading at its net asset value and yielding 6.2%. We went with the cheaper option.
Fast forward 20 months, we recently sold our stake in CMMT at a breakeven price. Including dividends, we made a total return of 7.3%. That may sound decent but remember that investing is also about opportunity cost. If we had invested in Pavillion REIT instead — a higher quality REIT with higher quality assets — we would be sitting on a total return of 26%. In addition to that, we would continue to hold onto the REIT and collect more dividends down the line. Unfortunately, that isn’t the case as we went with the cheaper, lower-quality REIT over the fairly-valued, higher quality one.
Looking at our personal investment returns over the past few years, we’ve noticed our best returns have come from investing in quality companies where we clearly understand their business models and how they’re able to successfully navigate their competitive landscape over the long term.
For example, our stakes in Alphabet, Facebook, Starbucks, Disney, Mapletree Commercial Trust, Parkway Life REIT, and SBS Transit have earned us between 23-111% returns to date. However, our investments in shipping (Cosco Shipping) and marine offshore engineering (Baker Technology) have yielded negative returns thus far. While any investment may turn sour at any time, the difference is knowing what to do when it happens.
In the case of a company/industry you’re familiar with, you’re able to make a more informed decision on whether to cut your losses or buy more. In the case of Facebook, for example, its crash in stock price after its privacy scandals signaled an opportunity for us to accumulate more because we understood its business well enough to be confident that it would overcome its immediate problems and continue to perform over the long term.
But when it comes to shipping and marine offshore engineering, we’re less well-versed in their industry dynamics and operations. (If you’re wondering why we went in, we made the same mistake as above – because the stocks were cheap.)
Investing in a quality company that’s within your circle of competence gives you an informational advantage. You’ll know when to stay for the long haul and when to head for the exits because you intimately understand how the business works.
When you understand a business, you stop blindly following the gurus or simply taking cues from the market when everyone else is panic-selling. You sell because you know that there’s a long-term structural problem with the business.
To do this, it’s crucial to build your own investment process. If you’re unsure how to, you can use our Investment Quadrant framework we developed at The Fifth Person to guide you. Run through a company’s business model, management, financials, and valuation and ensure that they pass all your criteria before you invest a dime.