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Saturday, June 28, 2008

Choices, choices, choices: A personal review, mutters & blabbers

Fellow blogger and famous Star writer - Dali - dropped a short note in my cbox last night.

"seng, forgot to tell u that tomorrow's article in the star is dedicated to u, tks for inspiring me to write Door 1 Door 2...lol remember"

Naturally, I took a quick look at his article this morning (grin). The full article is here - http://thestar.com.my/news/story.asp?file=/2008/6/28/bizweek/1433084&sec=bizweek. Reading it, it was clear to me that Dali has given quite a lot of thought on this topic. It is wide-ranging, and very thought provoking. Whilst I find myself in full agreement with many of his points, I also find myself surprised by some of his points. And I certainly wouldn't dare to claim credit for even 1% of the material written there. It is definitely his own sweat and effort (grin).

Because Dali has written a really thought provoking article, I thought I take the opportunity to provide a personal commentary (i.e. mumbles and blabbers) to a few of the more interesting points raised. For avoidance of doubt, he didn't pay me to write this article (grin).

"It boils down ... to a person’s net worth and their tolerance of risk." - Dali

Seng comment: This is a good point to remember. Each of us here has differing levels of net worth, and differing levels of risk (or pain) tolerance. We also have different ways in defining, thinking about and calculating "net worth". Some of us just think about the capital we set aside to trade stocks, others include all forms of assets less liabilities, and a few might even have plans for next month/s salary which has not yet arrived.

So, when you hear an analyst touting a good stock to buy, or get a stock tip from your colleague at work, friend, family or even directly from the Internet, don't just blindly follow.

He may say he's putting everything he has on this sure thing, but that might turn out to be $50k cash that he has, when his net worth is over $1 Million (if you include his business, his property, other assets, etc.) which he didn't tell you.

Or he may have a much higher tolerance for risk in that particular trade, and can sleep soundly when the stock price went from $1 to $0.50, but you already can't sleep when it falls to $0.90 and again he didn't tell you and you didn't tell him.

Or he may have a certain profit objective (e.g. 20% gain) and a certain stop loss (e.g. 5% loss) and predefined a certain risk amount (e.g. maximum loss not more than $1k) which you weren't aware of, but had you know, you will quickly realize that it is not suitable for you since you were thinking of a quick 5% gain, with no idea of stop loss, and thinking of risking all the money you set aside to buy a house next year.

Or a million other possible differences.

Hence the phrase: "No 2 person are quite ever alike".

"Is it any wonder then that the markets cannot be understood just via numbers and valuations alone. Things we cannot explain, we call them sentiment or momentum or over-sold or over-bought? You get the drift" - Dali

Seng comment: Markets definitely cannot be understood via reported business fundamentals alone. My opinion.

You might have thought about this phenomena before - e.g. company quarterly earnings reports. The business numbers are published just once (usually end of day) every 3 months, yet, prices can fluctuate hugely and daily during that 3 month period. So, doesn't that mean price movements not depend on business results alone?

News flow on the business is another attempt to explain price movements. Sometimes it works, but sometimes it doesn't and can have an opposite price reaction to what seems like a good/bad news. It is obviously grossly inadequate since the company news do not feature daily in the news, yet price moves daily. Same thing with analyst reports. It sometimes cause an opposite price reaction, and it isn't published daily. How does one explains price movements when there is simply no news?

The most often quoted answer (and has become cliched which is a shame) is supply and demand for the stock.

But it doesn't mean we must dismiss business fundamentals as useless. On the contrary, Fundamental investors' edge is the ability to decipher and deeply understand the business numbers, where together with other knowledge, one is able to project correctly how that business will perform in the coming year/s, and thereby ride out the "noise". In fact, lower "irrational" prices is often an opportunity to buy on the cheap. But the key is the ability to project correctly the future worth of the business. This is much tougher than it sounds. It is a fact that most people will get it wrong, seriously wrong. Very few if any can get it consistently right to the extent of being able to consistently make serious money out of it. And ironically, and invariably, most if not all these projections carry a very, very high degree of confidence level! Hence the phrase: "Surely they all cannot be right, despite their confidence!".

"...you will find investors, who usually start off with a proper well-researched decision on what stock to buy. The same person will make an illogical decision to cut-loss, or take profit too early because there were other factors that will come into the picture for them.". - Dali

Seng comment: I might be taking this particular phrase out of context, but I think some of you might find yourself in the current situation, where in your own belief, the decision to go long when the KLCI was 1500 was well-researched, and you now face a dilemma about what to do with your current holdings now that the KLCI has gone from 1500+ to 1200.

Should you cut loss? "But it was well-researched you might argue, so, maybe I shouldn't cut loss?" ... "But Seng said the majority analysis are wrong, so, maybe I could be wrong." ... "But I'm so sure I'm right! Surely I belong to the minority who can research well right?" (and if you keep second guessing yourself, you might go crazy like me right?)

The shortest answer is that there is no easy answers. :-)

But what I do know is never, ever let ego get in the way of rational, sound, objective decisions, even if it means you must cut loss. Cut loss is a huge topic in itself, if only because it is so difficult to execute stop loss for many, many people.

Values & Ethics

This is my favorite part. It is a topic close to my heart and one that inspires me to blog here and there, and to make comments in the blogs of others from time to time when time permits. Totally agree with the observation that ".... no one can say with absolute certainty until they have actually been posed with a real choice." - Dali

So, what is our Door 1 and Door 2? How do they appear? Do they knock loudly and announce that they have arrived? Or do we create the opportunities for Door 2 to appear when we only have Door 1?

If we are "lucky" to have Door 1 Door 2 right now, how should we think about the choices? Figure it out ourselves? Talk to trusted ones? Listen to gut instincts? Let ourselves be tempted by the saying "opportunities don't knock twice?". Or take the view that "opportunities are all around us, we just have to look at the right places"?

What about mentors? Those wiser than us? The wisdom within ourselves, our inner wisdom? Do we have enough quiet time to reflect? If not, you won't have the chance to even ask this question "What is your Door 2 value?". Some of us are so busy in our daily lives, that when prompted, our natural reaction is "Huh? Door 2? What Door 2? What is that scream? Huh? Is that the house burning down? OMG! ..."

But to spice this article up, let's take the perspective of a substantial shareholder who is also the M.D. and CEO of a company.

As the CEO, he has a lot of time in his hands to reflect about Door 1 and Door 2 and many other doors. In fact, he has already probably mastered the art of constantly looking for new doors, which probably brought him the CEO position in the first place. (And for some CEO, they don't even question their hidden JD - Job Description - which is to constantly seek and create as many Door 2 to benefit themselves first as much as possible)

But to keep things simple, let's say his Door 1 is his guaranteed regular salary of say $500k per annum (excluding bonus & perks).

His Door 2 might be this opportunity (in reality, he has many Doors daily). Let's keep it simple and say a possible profit opportunity of $5M, where by spending $20M of the company's money, he will use that to buy a property from his wife's company, where the property current market value might just be $15M say. And let's say he knows a valuer who can value it for him at say $20M. He knows the company's total gross assets is say $400M, so, a $20M purchase is unlikely to attract much attention. The purchase can be made legal as a matter of routine. He knows of a few others who has done it before, he knows his good personal MP friends has done it too and boasted to him before when they were holidaying in Australia, New Zealand or Hong Kong (grin). In short, low chance of being caught (who dares to pry into things that don't matter to us?), even lower chance of being prosecuted, the fine is minimal/small if convicted, the success payoff is high and a very high, if not almost certain chance of success.

Sounds familiar?

Obviously such a purchase is not in the minority shareholder's best interest. The purchase benefits the CEO's personal pocket, at the expense of minority shareholders.

How should the CEO respond to his Door 1 Door 2 choice?

And if minority shareholders realize that all CEOs always have this Door 1 Door 2 choices regularly, how should minority shareholder behave and respond?

This of course is a very, very tough question to answer. "I don't think I want to swallow that wake-up pill. Give me that sleeping pill again please".

As Dali mentions, rules and regulations only goes so far. Current reality is that it is inadequate. Just look at the size of Moolah's blog here - http://whereiszemoola.blogspot.com/. We cannot deny many cases has happened, and will continue to happen. Many more cases get off without being even detected. Very few cases gets charged in courts. Only a handful probably gets prosecuted, but none really gets a heavy enough fine to deter the rest of their peers. Current reality is it will continue, which is sad, unless there is a big enough TSUNAMI to change current reality.

And a Tsunami will never happen unless there is a big enough wave and force. It certainly won't happen if there is not even a ripple. In other words, it must start with ourselves. Do we recognize and accept, deep in our own hearts, that certain actions are right and wrong? If you sincerely believe that certain actions are wrong, have you considered lending public support and condemn that action if you can? If not, why not?

If the CEO is ethical, has a strong sense of what is morally right and wrong (usually but not necessarily from a strong and deep personal religious belief) and think like a shareowner first, then, he probably would do the right thing and quickly lock Door 2 , throw away the keys before even thinking of opening it. And he makes sure noone else finds the keys to unlock Door 2, or take actions to strongly deter/catch/penalize those who try to even open Door 2 for themselves.

Other CEO's who knows that personal reputation is a very important thing to protect might refrain from opening Door 2 also, since even just 1% chance of being discovered and reputations destroyed is not worth a lifetime of building one's career. Many CEOs are also deeply practical people and will act in the path of least resistance.

And therein lies the problem. A rare few shines like a beacon, a small minority may be trusted, many are borderline opportunistic, and some are simply no hope hard-core cases. What should you do, as a minority shareholder when we simply just don't know the CEO nor management that well? And we know that once-a-year annual meeting to voice our displeasure is so grossly inadequate for so many cases?

Recently, we discussed another different case in Moolah's blog here - http://whereiszemoola.blogspot.com/2008/06/lion-diversified-acquisition-of.html. You might be able to see what is a possible Door 2 if you stop and think about the Bursa announcement and ask the questions that Moo has asked. I can see some readers thinking that it is "unfair" for me to pick this case, out of possibly hundreds of cases each year, but to me, the issue is simple - if we haven't yet observe, we must start observing from somewhere. And that link is as good as any to start with.

Anyway ...

Back to this Door 2 topic for all of us who are neither substantial shareholder nor CEO nor MD.

Obviously, we all have our own Door 2's as well. Perhaps not as big nor as frequent as the hypothetical CEO above. Perhaps, it's as tiny and insignificant as "Should I take an extra pen home from the office stationary since the Mrs say we need one at home?"

Obviously, put in this way, live long enough in the real world and we all have faced Door 1 and Door 2 choices before. And since we are just human beings, how many of us can honestly say we have never made mistakes in our past choices? Have we done what we expect from ourself to rectify our past mistakes to the best of our ability then? Can we let go of the past? Are we ready to let go of the past? Unfortunately, we can never go back into the past to change things. And we cannot live in the past. But what should we do from here on, from this point onwards, after having swallowed the wake-up pill? Is the Door 2 choice illusory? Is our Door 2 just a Hobson's choice, i.e damned if we do, damned if we don't? Is staying on Door 1 is too painful to bear any longer, we simply have to take the chance with any Door 2?

Tough choices. Yet, "we always have choices in our life, more than what we initially think".

Ok. I think I better stop here. This blabber is getting too long, and this is one of the problems of having read a really thought-provoking article. All sorts of thoughts comes in and out, and I haven't even scratched a small fraction of what I want to say.

Happy thinking!


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