Investment philosophy of Tong’s Portfolio: Part 2 — Investing is always about valuations based on intelligent and rational assumptions
Value investing is a bottom-up investing strategy. One usually starts by sieving though the universe of stocks using various valuation metrics such as price-earnings (PE), price-to-book (P/B), dividend yields and return on equity to search for undervalued opportunities. It is fundamentals-driven research — that is, analysing the company’s historical earnings, cash flow and balance sheets as well as growth prospects to derive its intrinsic value, which is the sum of future discounted cash flows (DCFs). In other words, the numbers are not all the same for every investor, as some are based on “expectations”. As we wrote last week, it is our fundamental belief that valuations will eventually reflect intrinsic value, even though stocks can and do trade above or below their fundamental worth in the shorter term for a myriad of reasons.
To quote Benjamin Graham, often regarded as the “father of value investing”: “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
What this quote means is that in the short term, stock prices are determined by “popularity”. In other words, they are dictated by market supply and demand, which are driven by near-term earnings changes and emotions — greed and fear are exaggerated by storytelling, speculation, hype, herd mentality and even memes, as seen in recent years. Stocks end up being overvalued or undervalued relative to their intrinsic values. The objective for value investors is to capitalise on this short-term market mispricing, that is, investing in stocks that are undervalued by the market relative to their intrinsic or fundamental worth. In the long run, pricing anomalies should correct, and stock prices will ultimately reflect their underlying worth.
Warren Buffett once said: “Price is what you pay; value is what you get.” Buffett was a student of Graham, whose teachings played a huge role in shaping Buffett’s (and Tong’s Portfolio’s) investment philosophy. Buffett is, of course, one of the most respected and successful investors of our lifetime.
We, too, are value investors. This is why Asia Analytica Data owns its proprietary financial database, which is kept up to date by three full-time employees. We use this database to start our search for undervalued stocks. Subscribers would be well aware of the range of specially tailored and easy-to-use tools that are available (we share them all). Interested readers can check it out at www.absolutelystocks.com. To state the obvious, value investing requires patience. It is not for traders looking for quick gains — value investing provides opportunities for those willing to expend some effort on research to profit in the long run.
See also: Secular fall in global supply of CPO implies more upside for Malaysian plantation stocks
A good example of a value stock in our current Absolute Returns Portfolio is Hong Kong-listed Swire Properties. The company generates the bulk of its revenue from rental income — primarily from offices (about 43% of total rental revenue in 2023) and retail (53%) properties located mostly in Hong Kong and Mainland China. Its earnings have been on a downtrend in the past few years as a result of the downturn in Hong Kong’s property market.
The commercial property sector downturn started in 2020 and was exacerbated by the Covid-19 pandemic (remote and hybrid work reduced demand for office spaces), the ensuing economic weakness in both Hong Kong and Mainland China, as well as market oversupply. Overall Grade-A office vacancy rates have increased sharply, to 13.3% at end-October 2024, with an estimated surplus of 10.6 million sq ft. Correspondingly, rental rates have declined, particularly in pricey Central and more broadly across Hong Kong island (where most of Swire Properties’ office properties are located).
Property market analysts project office vacancy will continue rising till at least 2027, given the incoming supply (outpacing demand) of competitively priced office spaces in Kowloon East and New Territories, which are the focused growth areas in China’s Greater Bay Area development blueprint. Hong Kong office rentals are seen to decline further in 2025, to a 15-year low. While Swire Properties has sought to diversify its income base in recent years, by growing the retail property portfolio in Mainland China, demand is also likely to be relatively muted, given the slowdown in consumer spending in the world’s second-largest economy.
In short, we do not expect to see a significant earnings recovery for the company over the next two to three years. Unsurprisingly, its share price has fallen sharply from the peak in 2019, mirroring the decline in earnings (excluding fair-value changes) (see Chart 1). As a result, valuations have also contracted sharply — its price-to-book ratio fell as low as 0.25 times earlier this year compared to the average of 0.45 times (ranging from 0.35 to 0.57 times) between 2012 and 2019 (see Chart 2).
We believe that most investors are short-term-oriented. That is why share prices often show outsized reactions to the release of earnings results. For example, it seems to us that the entire US market is always on edge in the days running up to Nvidia’s quarterly results, which can make or break the market rally.
Value investors focused on long-term fundamentals can exploit this market “short-sightedness”. Swire Properties’ share price reflects its earnings decline, though it has rebounded a little since hitting record lows in July 2024. Priced at 0.33 times book value currently, however, the stock still offers a pretty good risk-reward proposition over the longer term.
This bottom-up value investing approach has served us very well in the past for our stock picks for the Malaysian Portfolio. Using our own database and the tools that we have customised specifically for this purpose, we have discovered many gems among smaller-cap stocks, most of which are under-researched — and therefore undervalued — by analysts.
Almost all of our current investments in the Malaysian Portfolio are chosen using this same approach. For example, shares in United Plantations and Kim Loong Resources have far outperformed their larger peers over the past year or so — owing in large part, we believe, to their relative undervaluation in the past. Even now, after the price gains, both stocks are still trading at lower PE multiples compared to those of, say, SD Guthrie and Genting Plantations. Johor-based property developer KSL Holdings is priced at less than five times earnings and 0.46 times book value; and Kumpulan Kitacon is trading at eight times trailing earnings, roughly one-third the prevailing average valuations for the 10 largest construction companies on Bursa Malaysia.
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The same strategy has been less effective for us when applied to foreign stocks, though. From our post-mortem analysis, we believe this is due primarily to our lack of in-depth knowledge of foreign markets, the business environment and idiosyncratic risks that only locals would understand. And this raises the risks, given the anticipated long holding period.
Stocks can be undervalued for different reasons. Some undervalued stocks will stay undervalued even in the long run. As we explained last week, one of the biggest reasons is management integrity and governance, which is a more critical factor for investors than any mathematical calculations of intrinsic values. Management that lacks integrity is more likely to engage in self-serving behaviour to the detriment of shareholder interests — and especially of minority shareholders who have little control over management decisions — and, in the process, often destroys value. Bad management will eventually run even good businesses aground.
There is a high percentage of stocks on Bursa and Singapore Exchange that have traded — and continue to trade — at huge discounts to their book values for years. Many of these companies have shown little motivation in more active capital management and enhancing returns for minority shareholders. Therefore, it is not surprising that there is correspondingly little interest from investors that would boost the stocks’ liquidity and valuations.
Low and falling stock valuations over time could also be due to discounting for macroeconomic as well as industry and company-specific factors such as politics and geopolitics, weak industry outlook (for instance, disrupted by tech advancements or regulatory shifts), market saturation, the company’s permanent loss of competitive advantages and so on. It is important to understand why a stock is cheap before buying it. Value investing requires more rigorous fundamental research.
In Swire Properties’ case, we think its current undervaluation is cyclical — earnings and share prices dropped because of the property downturn but will eventually recover into the next upcycle. The company is 82%-owned by Swire Pacific, which is also the biggest shareholder in Cathay Pacific Airways and the flagship listed company of the global conglomerate Swire Group. The group has a long and solid track record in terms of corporate governance and enhancing shareholder value.
For instance, Swire Properties has consistently raised dividends for shareholders, through capital management, since its listing in 2012. Dividend yield for the trailing 12-month period is an attractive 6.8%. Despite lower earnings and higher dividends paid, gearing remained modest at 12.7% at end-2023 (see Chart 3). The company also initiated its first-ever share buyback in September 2024, under a programme totalling HK$1.5 billion (RM860 million) to be deployed by May 2025.
Our most recent acquisition, MAP Aktif Adiperkasa (MAPA), was also a stock discovered based on fundamental analysis and value investing principles — with one material difference. The stock is not hugely undervalued like Swire Properties. The truth is it is not easy to find truly undervalued stocks (particularly in foreign markets as we have explained above), since markets are (mostly) efficient and there is intense competition among investors — many employing advanced algorithms on big data — that continuously enhances the price discovery process. Thus, many stocks that appear “undervalued” are cheap because they have reasons to be so — for example, owing to questionable management integrity and trust issues.
Tellingly, Berkshire Hathaway’s cash pile has been on the rise for much of this year, topping US$325 billion in the latest quarter, suggesting a lack of attractive investments. Buffett said during the company’s AGM in May that he would not deploy the cash “unless we think we’re doing something that has very little risk and can make us a lot of money”. Berkshire’s record cash hoard suggests that Buffett is becoming increasingly cautious about overvaluation in US stocks. That includes Berkshire’s own shares, since the company has also paused share buybacks.
US stock valuations are higher than longterm historical averages, even excluding the tech sector. The very high expectations currently built into stock prices leave little room for disappointment.
The stock market in the short term is a market for stocks, and prices are determined by demand and supply. When most people already own the stocks, the marginal propensity for more buyers declines. Meaning, it is more likely for stock prices to fall as demand falls, and vice versa. As Buffett has often advised, the best time to buy stocks is during crises, when fear is running high and prices fall well below intrinsic values.
Of course, timing the market is exceptionally difficult and, for the average investor with limited funds, it makes little sense to stay on the sidelines for an extended time. One must start building wealth as early as possible to maximise the benefits of compounding. Time in market is critical. Berkshire, on the other hand, can depend on growth from a diversified base of core operating businesses that are profitable and generate cash flows, aside from its investment portfolio.
Having said that, Buffett’s investment philosophy has also evolved over the years, influenced by his business partner, the late Charlie Munger — from his earlier years’ strategy of “cigar butt” investing (buying distressed or mediocre companies at bargain prices) to one that focuses on quality companies with growth. “The blueprint Munger gave me was simple: Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices.” A good application of this philosophy is our current investment in Gamuda. While the stock is not cheap, we believe it is reasonably valued for its quality and prospective growth.
We think MAPA has the makings of a wonderful business — with latest quarterly sales growing by 25% year on year while its shares, though not “dirt cheap”, are reasonably valued at 20 times trailing earnings. The company is the sporting retail arm of PT Mitra Adiperkasa Group (MAP), Indonesia’s leading lifestyle retailer. It was listed on the Indonesia Stock Exchange in 2018.
MAPA is currently the largest sportswear retailer in Indonesia, with about 70% market share, and a proxy to expected robust economic and consumption growth in the country. Indonesia has a large working-age population (and total population of 277.5 million) — the median age is only 28 — and rising purchasing power.
London-based market research company Euromonitor International projects Indonesia’s sportswear market to grow at a compounded annual rate of 12% from 2023 to 2028. The upbeat outlook should continue to drive growth for MAPA. The company’s sales and profits have been on a broad uptrend, save for some disruptions during the pandemic and a period of inventory rebalancing post-pandemic, which affected margins (see Charts 4 and 5).
MAPA sells a large portfolio of more than 150 international brands — such as Adidas, Asics, On and Nike — and has exclusive distribution rights for more than 40 brands in Indonesia, including Hoka, Skechers, New Balance, Converse, Foot Locker, Birkenstock, Clarks and FitFlop, through its omnichannel retail network. It has 1,336 stores across 80 cities throughout Indonesia at last count, which generate roughly three-quarters of the company’s sales, as well as 310 outlets in the region, including in Vietnam, Thailand, the Philippines, Singapore, Malaysia and Cambodia (see Chart 6).
In a nutshell, value investing as an investment philosophy has stood the test of time. It is a fundamentally driven bottom-up approach. It requires rigorous fundamental analysis, patience and discipline. We are value investors. There are also obvious limitations to this strategy, though, given that much of the fundamental analysis — cash flows, earnings, dividends and balance sheets — are necessarily based on past performances. We will elaborate on this in our next article and how we have adapted our stock-picking process.
The Malaysian Portfolio fell 0.7% for the week ended Dec 11, in line with the broader market decline. Gamuda (+4.0%) and IOI Properties Group (+3.3%) were the two gainers for the week, while the big losers were Insas Bhd Warrants C (-6.3%), Harbour-Link Group (-5.3%) and KSL Holdings (-3.4%). Last week’s losses pared total portfolio returns to 205.2% since inception. Nevertheless, this portfolio continues to outperform the benchmark FBM KLCI, which is down 12.4% over the same period, by a long, long way.
The Absolute Returns Portfolio lost 1.7% last week, paring total returns to 18.9% since inception, dragged down by heavy losses from Uber. The stock fell 15.2% following two negative developments over the past few days. Waymo, one of its partners in autonomous ride-hailing, chose to join up with Moove for fleet management in Miami. This was followed by General Motors’ shock announcement to exit its robotaxi development in loss-making Cruise (another of Uber’s partners). Other notable losers include Talen Energy (-5.0%) and CRH (-4.6%). Palantir Technologies (+3.8%), Swire Properties (+2.3%) and OCBC (+1.9%) were the three gaining stocks last week.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
