PARKSON & A Position Size Idea in face of Uncertainty

This article is dedicated to “dorraidd” who discussed Parkson passionately with me in my chatbox today, and kindly urged me to cut loss. I thank you for your kind advice. The article is also dedicated to all readers who wishes to explore alternative, non-standard position sizing idea. A disclaimer: I don’t necessarily practiced it exactly this way, although I do own Parkson at the time of writing.

PARKSON (5657.KL) is a stock that is popular in my chatbox, especially amongst the “investors” such as “bullbear” and “cycle” whom some would say are “die-hard” fans of Parkson stock. Dali (chatter, blog owner of Malaysia Finance blog) also likes it from a business perspective in the past, although lately he has been rather quiet about this stock. Of course, a local fund manager has also touted this stock in the Star recently and in his advisory services for a rather long time. (http://biz.thestar.com.my/news/story.asp?file=/2008/5/29/business/21384745&sec=business) As for me, from time to time, when I have vested interest (such as now), I will write about the stock too (smile). So, do be aware the vested interests involved when you read the cbox, newspapers, analyst reports, etc.

Having said this, the reason why Parkson is highly favored as a business is quite easy to imagine. Think past spectacular growth results and exciting future prospects from the huge China retail population. Think China economic miracle, rapidly and continuously growing and unstoppable rich and middle class with greater and greater purchasing power over time, proven business model in China and scalability to other areas, think untapped demographics and the huge 1.3 billion population, non-saturation even over the next 10 to 20 years in future, etc. There are many, many better and more skillful writers who can paint a better picture about the future prospects of Parkson’s business, as well as its phenomenal past growth.

However, the truth is deep inside me, I am not 100% convinced with such stories. Why? Because Parkson trades at a high P/E and its price action volatile. I immediately think of Green Packet and Top Glove, both of which were previously high growth stocks and now got punished hugely when they don’t deliver the earnings growth. Green Packet more than Top Glove.

But I must also say, that unlike Green Packet and Top Glove, Parkson does have the unique China appeal, making its growth story more robust. (I think you can see how torn apart I am). The dilemma is China growth – if Parkson can no longer grow its earnings from such a huge market potential like China, then which company can? Of course, Parkson also has operations in Vietnam and Malaysia, although we know the earnings contribution from these 2 countries are small, and the vast majority (nearly 90%) is from Greater China alone. As a trader cum investor, the question is how to take advantage of current low price (Reference : $5.6). Is this low price an opportunity? Or is it a bear trap? Or is the low price going to become high price in future?

In this situation, I personally find it useful to look at the situation from as many perspectives as possible.

The first perspective I would start with is that of a chartist trader. He would look at this chart here:

And he would probably say “UGLY” – don’t touch it. Why?

Well, if one is a trend following trader (trend following traders typically want a go signal from either trend following indicators such as MACD, Moving Averages, or a bullish looking chart pattern), then, Parkson does not fit the criteria. MACD is still moving downwards. EMAs across many durations are pointing downwards, even a downtrend is visible since the peak on 2 Jan 2008. So, trend-following traders would probably wait for the downtrend trend to reverse itself first, before thinking of jumping in. These include break-out traders as well.

What about the “oscillator-type” traders who buys low and sell high within a channel? Well, in such a situation, the stochastics would clearly show “over-sold” conditions across a wide range of parameter, and such suggests possible “Buy”, although experienced stochastics traders know that in a prolonged downtrend, they can indicate “over-sold” for quite a long time. And trading a channel that is declining is not exactly high probability stuff. So, prudent oscillator-type traders would also probably wait for a little while first.

Even traders using candlesticks would also not consider touching Parkson, as there is simply no “reversal” signal yet.

In short, I would think 90% of the professional traders probably won’t touch Parkson at end of today, at 4.59 PM.

However, as usual, when the price of what is perceived as a wonderful business comes down, another group of investors starts to salivate and get excited. These are the true investors, who wants to buy when the price is low and when they think it is a bargain. The question is is it a bargain at $5.6?

There are many types of investors, but probably the largest group of investors are those who likes the Sum of Parts of Parkson. As you know, Parkson operates in 3 countries – HK, Vietnam, Malaysia, and the proponents usually – for simplicity – put a zero value for Vietnam and Malaysia operations for convenience, even though both operations are profitable. The reason is because the earnings contribution is small. Whereas for Parkson HK, it is listed in HK Stock Exchange, it’s a fairly liquid stock, and so, the market value of the stock is easily referenced. In fact, Parkson owns approximately 53.5% of Parkson HK, and so, at closing price of HKD61.5, and using an exchange rate of 1 RM = HKD2.45, yields a Market Value of approximately RM7.5 Billion. When divided by 1.04 Billion shares outstanding currently, this gives a Market Price of say RM7.2.

Now, this is not the only way to put a value for Parkson, since even amongst the Sum of Parts practitioner, there are a huge variation of practitioners. E.g. some would argue that since Parkson also have approximately RM500 M Redeemable Convertible Secured Loan Stock (or RCSLS) of which RM195M has been converted leaving RM305M left, which represents approximately 76M additional Parkson shares, the price should not be divided by 1.04 Billion but 1.11 Billion. This gives a price of say RM6.7. But I think this does not give credit to the improved Balance Sheet after such conversions, not to mention that when such loans are converted to stocks, there is no longer any interest payments which represents savings. So, I would still put more weight on RM7.2 figure than RM 6.7 figure. Perhaps there is a spectrum there.

But more importantly, the Sum of Parts valuation assumes that HKD61.5 is a true and fair value for Parkson’s business. Investors are generally longer-term and patient people, and the fluctuation, current market value is not often a benchmark that determines the value. Herein lies a paradox, in that Sum of Parts valuation uses Market Value, but they don’t want to use Current Market Value! One variation wants to use Target Price for Parkson HK, which again, varies by analysts but generally speaking, far above HKD61.5. Parkson HK price peak was HKD91.5, and today’s price is quite a big fall from its peak on 11 Dec 2007. Knowing how analysts operates, I wouldn’t be surprised if back in Dec 2007, their TP is higher and possibly close to HKD100, but after the huge recent fall, expect them to downgrade the TP lower but still higher than HKD61.5.

And then, there is the “fusion” valuers who combines both TA and FA to get an idea of the fair value of Parkson. But these guys are probably rarer (since the discipline is to differentiate TA vs FA in valuation, i.e. valuation typically do not incorporate TA price targets in their valuation) and doesn’t appear to influence large institutional funds based on past analysts reports that I’ve read.

Looking from the perspective of the institutional holders, again, most of the stories sold are based on valuation and its future prospects. TA is not ignored, but not used alone for long-term position type holdings. It is interesting that the most recent reference is a “left hand” selling to “right hand” at market price is around HKD67.45 transacted at end May 2008. Prior to that on 9 Jan 2008, they were able to place a block of 8 million Parkson HK shares out at HKD78.66, a considerably higher price than HKD67.45, but close to market prices then. The gap between HKD61.5 vs HKD67.45 and vs HKD78.66 is quite large, ranging from 9% to 22%. So, current market price HKD61.5 seems low, although market prices are still market prices. And because Parkson holds Parkson HK, the market likes to apply a 20% discount factor, although in the original reasoning to split Parkson business from LIONDIV, it is argued that such an exercise should “unlock” this discount factor. Still market forgets, and revert to applying the 20% discount factor, and then, change their minds and spikes up each time Parkson disposes its HK shares at market prices. Such is the fickle and nature of market prices.
In short, there is a wide variety of investors, but the general consensus amongst this group is that Parkson is looking cheaper as the price falls. Nothing surprising there.

So, for someone like me who sees both sides, it’s quite a difficult decision. Buy or don’t buy? And how much?

I think the decision is very much individual and depends on one’s investment objectives too. Also, the current political uncertainty, the after effects of Vietnam stockmarket/economic/currency collapse, the present unresolved US uncertainties, etc. means that whatever the decision is, it is vitally important to make sure that if one buys Parkson, then, the total risk of loss should be small when one cut loss.

In other words, what I’m thinking is is there a way to combine both FA and TA in deciding the position sizing?

Let me explain more.

Currently, one of the attractions of Parkson is that maybe, the Parkson HK price is supported at say HKD50, which is a strong horizontal support. There is another higher support at HKD59. If price is an indicator of companies health and smart monies understanding of company’s health, then, one could say that Parkson’s business may still be healthy if the price does not fall below HKD59 or below HKD50. In other words, one possible strategy is to cut loss when Parkson HK price falls below HKD50 say.

In other words, when Parkson HK price is “healthy”, then, any local Parkson price dips is seen as opportunity to accumulate but when Parkson HK price crashes, one cut loss.

Let say the risk of loss when this happen is preset to 2% capital. Let say for simplicity, capital is $1 million. In other words, in the worst case scenario, you cut loss and the maximum loss is $20,000.

The question now is at what price should one enter, and how much?

Now, at HKD 50, Parkson is equivalent to $5.88. So, the current price appears to be a bargain in this respect. So, can we design a buy in schedule so that at progressively lower price than $5.88, we would buy increasing amount, but below the stop loss price, we would sell out completely so that the total loss is only $20,000?

On the local charts we see Parkson have a support of $5. The 22 day moving average of the True Range for Parkson is around 27 sen. Let’s set the stop loss at say $4.7. Let’s assume for simplicity commissions is 0.5% per trade. Let’s say we want to progressively buy in more as the price falls, in 10 sen steps, from $6 to $4.8. And at $4.7, we will cut our loss and sell out and lose $20,000. The question then is how much to buy at each price? Let say at each price we risk $20,000 / 13 = $1,538. 13 because we note that there are 13 possible buy ins, from 6, 5.9, 5.8, 5.7, 5.6, … all the way to 4.8.

So, how much to buy in? Here is the full schedule:



Do try to study this schedule carefully since it's the heart of this article. This schedule needs interpretation. What it says is that at each price from $6 to $5.7, you buy 1,000 Parkson shares only. At $5.6 down to $5.3, you buy 2,000 shares. And at price 5.2 and 5.1, buy $3,000 shares. At $5, buy another 4000 shares. At 4.9, buy 6000 shares. At 4.8 buy 10,000 shares.

In other words, you scale your entry in. Buying much larger amounts as prices fall.

There are advantages and disadvantages with this approach. Start with advantages first.

1. As price falls, you buy more and at an increasing rate as price gets lower without exhausting capital.

- In fact, at 4.8, the buy is 10,000 shares, much larger than all previous buys.

- If local Parkson price falls to $4.8, then, you should own 38,000 shares in total at a cost of $196,277, or 19.6% capital.

- The average price paid is $5.17 after commissions, which is near the low. (do appreciate this difference, since the average price between 4.8 and 6 is 5.4, which is higher than 5.17)

- And if Parkson price recovers to $6, then, the gain is 16%, or $31.7k, or 3.2% capital.

2. Chances are (no guarantees) - you shouldn’t need to execute your stop loss at $4.7 if Parkson HK remains above HKD50. Of course, do use a different figure and recalculate all this so that syndicates to run your stop. Consider setting the stop higher, so that if they do run it down to $4.7, then, you can buy it back cheaper. Or alternatively, set the stop lower than $4.7 so that they won’t think of running the price down to $4. Basically keep them guessing.

3. Even if you need to execute your stop at $4.7, you have preset the maximum loss to $20k. In fact, it turns out that it is $18.6k, or just 1.86% capital.

4. The Reward to Risk potential is good – a respectable 1.7 times and this is already net of commissions. If the loss is not executed, and price recovers, the trade is profitable, with low risk of loss.

5. The small buys starting from $6 is designed to keep your "itch" to buy in check. Basically, you don't buy big at high prices, but small at high prices, and it scratches the strong itch to buy.

Some disadvantages:

1. Hard to understand and apply in practice at first. But like any new skill, once it is learnt, it becomes easier, and one day, 2nd nature. For someone like dorraidd, I think the schedule should be fairly obvious to him in an instant glance.

2. Possible Inefficient use of capital. If the price doesn’t fall to $4.8, but stopped at say $5.2, then, you haven’t bought the full 38,000 shares (or 20% capital), and you end up sitting on a lot of cash.

- Think a little bit about this.

- Is this good or bad in face of uncertainty?

-In fact, if price drops to only say 5.2 (and not the full 4.7), you would only accumulate 15,000 shares at the cost of 83k, with an average price of 5.53. So, just using 8% capital, keeping 92% cash when price drops to $5.2. And not executing stop loss at all if price goes up after hitting a low of $5.2.

This of course is not an exhaustive discussion about the pros and cons of the strategy, but it’s something for someone with sophistication like dorraidd to study and perhaps comment on.

Of course, the actual position sizing method I am using is different from the above. (smile) I can’t give away all my secrets right?

Happy Reading!

Disclaimer: As usual, buy/hold/sell at your own risk.

Some thoughts on Position Sizing

“[Soros taught me] it’s not whether you’re right or wrong that’s important, but how much money you make when you are right, and how much you lose when you’re wrong.” – Stanley Druckenmiller

When novice invests in the stock market, they are usually full of hope and optimism. They tend to only consider the upside (and target price), and usually ignores stop loss, before putting on the trade.

Perhaps this is due to the prevalent myth of a “perfect stock-picker” or “perfect stock-tip” – the perfect investor or tip that always pick winners and never makes mistakes. Sadly, that is a myth. Invest long enough, and soon, everyone will have a loser in his hands. This is stock market reality. Show me someone who has made 100 trades with 100 winners and he/she is a liar. :-)

It is not common to read this, but even the Best of the Best, the master investor and the world’s 2nd (or 3rd) richest man – Warren Buffett – has made his share of investing mistakes and continues to do so even today. Don’t believe me? Well, take a look at this site and look at the first entry – BAC (Bank of America). BAC is a relatively recent purchase (mid this year), and to date, Buffett has an unrealized loss of 13%. So, even the Best in the world still makes mistakes.
http://www.gurufocus.com/StockBuy.php?action=buy&GuruName=Warren+Buffett.

So, if Buffett continues to make mistakes, and we lesser mortals also make mistakes, how is it that Buffett has managed to amass such a huge amount of wealth that far exceeds our own experience let alone our wildest imagination? Remember that Buffett starts from nothing, like most of us. What is it that truly separates Buffett from the vast majority of investors?

Well, we’ve heard many reasons mentioned elsewhere such as his unparalled ability to determine intrinsic value of a business, margin of safety, ability to accurately assess business future prospects and risks, ability to assess management honesty, integrity, competency, understand company financials and business models, amazing memory, his infinite patience to wait for the “fat pitch” even if it means waiting for decades for the right opportunity to come along, his people and business management skills, etc. etc. etc..

But despite all these wonderful abilities, the bottom line is he still makes mistakes. Period. His recent BAC purchase is a timing mistake – 13% loss. His recent Petro China sale at $12 which is well below the peak of $20 is a timing mistake. And many, many more. But despite these mistakes, how is it that he is worth billions of US$ and his millions of “twin investors” (in the same 55 years investing period) aren’t ?

I believe the main and the least understood reason is because he is also a Master in “position sizing”. Bottom line is that when (not if, but when) he makes mistakes, his mistakes tend to have minimal impact on his total capital. But when he is right, his bet has a huge impact to growing his net worth. He aims to preserve capital and score home runs by only betting big in situations that he has the most confidence in. And he avoids bets that don’t meet his strict criteria. When he is winning, he adds more to his winning positions including not selling his winners which has grown to become even bigger % of capital over long periods of time (e.g. Coca-Cola). When he is proven wrong (e.g. adverse earnings results on Pier 1), he doesn’t throw good money after bad ones by averaging down, but instead sell out.

Buffett is well known to have infinite patience and waiting for the “fat pitch”. What does a “fat pitch” means? Well, it is a baseball term, where the batter will only swing at the ball when it is at the most favorable zone. In other words, he will swing only when the ball is at the ideal position for the batter to score a home run. He will not swing until he gets the perfect pitch, or the “fat pitch”. In other words, he will only invest in situations that meet his strict and successful criteria.

But occasionally, he will be presented with more than 1 opportunity that meets his criteria. E.g. he may be looking at several eligible opportunities, each with different % return on capital. In such a situation, I believe Buffett will automatically puts bigger amounts on the higher % return on capital opportunities subconsciously and without hesitation. His frequently quoted yardstick is to always compare with his best existing investment (such as Coca-Cola). He will not invest in a new venture if the return on capital is lower than Coca-Cola. Instead, he will prefer to add more Coca-Cola if the pricing is right.

It is also worth noting his “buy and hold forever” approach. When he is right and a stock price starts to appreciate, does he sell? Unlike most of us, he doesn’t sell. Again, Coca-Cola is the most obvious example. He has held that stock for decades now that Coca-Cola has grown to become the number 1 stock holding for Berkshire for many, many years. As Coca-cola grows to become a higher % of Berkshire’s capital, he is happy to do nothing and just let his winners grow. He is not concerned that Coca-cola has grown to become “too large” a % of Berkshire’s capital. All he is concerned about is making a meaningful amount of money when he is right.

And indirectly, this is also a passive form of “position sizing” for him, since he continues to hold even bigger positions in his long-term winners like Coca-Cola which continues to make even more money over time.

So, what can we learn from the above? Can we break down the main principles of position sizing? How do we mortals decide how much to invest in a trade? To me, mathematically it boils down to 3 things:

1. The odds of winning and losing. Other things equal, you want to bet larger amounts in trades with the highest odds of winning. This means you must acquire and learn the ability to distinguish and rank trade opportunities since not all trades have equal odds all the time. And you want to avoid trades where the odds are simply 50/50 when you are simply uncertain. Here, Kelly’s Optimization Formula for even-money bets may be useful for value investors who like the precision of mathematical formulas. http://en.wikipedia.org/wiki/Kelly_criterion. In fact, the Motley Fool calls it “the Most Important formula in investing”. See http://www.fool.com/investing/value/2006/10/27/the-most-important-formula-in-investing.aspx.

2. Risk/reward trade-off. Besides the odds of winning and losing, there is also the amount which one expects to win when one is right (=Reward), versus the amount that one expects to lose if one turns out to be wrong (Risk Amount). Value investors demand bigger margins of safety to bet big, since the bigger the margin of safety, the bigger the potential reward and the smaller the risk. Traders sometimes calculate these as Reward = Target Price – Current Price, and Risk = Current Price – Stop Loss price. Mathematically, there is no real distinction between how a value investor and a trader calculates Reward – the difference is definition and semantics. Basically, other things equal, you want to bet bigger amounts when the Rewards substantially offset the Risks. The Kelly general formula gives an optimize formula to maximize equity growth to determine this.

3. Your accuracy in assessing 1. and 2. above. In the investment field, there are surveys and studies that show that most investors tend to over-estimate their ability in sizing up the winning odds, and tend to under-estimate the odds of losing. It’s a bit like surveys showing that most drivers tend to think that they have “above-average” driving skills – this is clearly impossible, since objectively, “the majority cannot be above-average”. For value investors, a formula like “half-Kelly” (or a fractional Kelly) could be useful here, to compensate for the initial over-estimation. As one becomes more competent later, the formula could be fine-tuned to tailor to the individual.

Whilst Kelly is typically applied to value investors, the 3 principles above can also be applied to traders, although the details usually differ due to the different approaches. E.g. for 1., some traders avoid trades with less than 60% (or another %) chance of success and only focus on trades with more than 60% chance of success, based on technical charts or some other criteria. For 2., some traders avoid trades when the Rewards are less than twice the Risk (or some other parameter). For 3., the actual position size is sometimes calculated based on a constant % of capital at risk approach (instead of Kelly’s). Basically, this approach starts off by setting a certain fixed % of capital which a trader is willing to lose from a trade if his trade goes wrong – typically, 0.5% to 2% of capital. E.g. if one has $100,000 capital and one is willing to risk 1% of capital or $1,000 in the event of a stop loss, then, the amount one would invest will depend on the gap between current price vs the intended Stop Loss. If the Stop Loss is near the Current Price, the position size is larger than if the Stop Loss is further away from the Current Price. E.g. if Current Price is $1, and Stop Loss is $0.90, then, the number of shares to buy = $1,000 / ($1 – 0.90) = 10,000 shares = $10,000 = 10% of capital. The idea is that if the stop loss is executed at $0.90, the loss = 10,000 shares x 0.10 loss = $1,000 = 1% of capital. This assumes perfect stop loss execution with no slippage. In reality, some allowance must be made for these. Depending on the perceived odds, they will vary the amount of capital at risk, such that on trades with the most confidence, one may place more capital at risk, and vice versa.

Some Concluding Comments

The concept of position sizing is not usually obvious to beginning and average investors. It is only too common to hear the average Bursa investors asking their tipster or “gurus” WHAT stock to buy. Visit any investing blogs with chatboxes, and the most popular question when it comes to tips by far may be “WHAT STOCK to buy?” The second and third most common question is “WHAT PRICE to buy and WHAT is the Target Price?” It is less common to hear “what is the stop loss price?”. And perhaps a question that we almost never hear is “how much” to buy, or what % of capital to buy. And unfortunately, the last question may in fact be the most important question of all, in terms of the impact on total equity growth.

Why? Well, imagine you’ve made 3 trades – the first 2 successful and the 3rd unsuccessful (67% success rate is not a bad rate). Let’s say 10% gain, 50% gain and 5% loss respectively. If your largest position is the 50% gain, then, you should come out well on your total equity. But if your largest position is the 3rd trade with 5% loss, and your first 2 trades are very small positions, then, you can actually end up with an overall net loss. Despite scoring 10% and 50% gains!

Don’t believe me? Well, prove it to yourself mathematically. Imagine you invest $3k each in the first 2 trades. And imagine you invest $50k in the 3rd trade. Your net loss is 3000 x 10% + 3000 x 50% - 50,000 x 5% = - $700 (or $700 loss).

So, in conclusion. As you become more competent in investing and trading, pay more attention to position sizing. Better, learn from the masters (whether master investor or master trader) how they approach the issue of position sizing.

On a personal note, I want to share with you my own personal investing experience recently which has convinced me the importance of position sizing. I am very proud to say that my recent Petrochina Call Warrants trades have given me the largest $ gains I have ever had from a single investment ever in my entire life. Petroch-C1 has the most amazing run from a low price of below 5 sen on Aug 17, to a high of $1.11 on Nov 5. I first entered PetroCh on June 8, but it was a very small position. On Aug 17, I managed to get a very small position at rock bottom prices, but sold too early, and then, kept buying more on its way up. On Nov 2, PetrochC1 & C4 represented nearly 30% of my entire capital! (this is by far the largest amount I have ever had on a single stock, when my previous principle is never to have more than 5% of my capital in any single stock, let alone a Call Warrant!). Finally, on Nov 5, due to its uncertain price action, I decided to sell all of my Petroch-CW holdings at around Nov 2 closing prices. In $ terms, the returns from Petro CW alone (in 3 months) is more than 3 times my largest gain to date then (MAYBULK, after nearly 2 years of value investing). There are 2 critical lessons for me from this experience. First, when you are right about a stock, don’t be afraid to keep adding more on its way up – I was adding Petroch-C1 at increasing prices, even when it was trading at 80+ sen at new highs. I have actually done this many times before with other stocks, but the difference with Petroch-CW is the stark difference in “position size” – I was around 80% confident in Petrochina, and according to half-Kelly’s formula, I should aim to have around 30% of my capital in it. Second, when you are in an uncertain position – and this happened on Nov 5 when the mother share could not sustain its rise past $20 – I quickly liquidated as much as I can. I had no business playing CWs when I am uncertain on its future outlook – again a Kelly formula with 50/50 odds suggests nil holdings. Again, I have practiced this many times before, but the difference this time is that I am willing to let go 100% (or as close to it as I can) when I am uncertain, as opposed to the normal practice of retaining half. And this is an important aspect of position sizing too. As a result of an overall much improved position sizing experience from entry to exit, I have already observed a substantial and almost immediate improvement to my own personal equity results.

It is also worth noting that I did reenter Petroch-C4 at prices between 65 to 70 sen after Nov 5 (after having sold them at close to 90 sen on Nov 5), but this time, because the outlook is much less certain, my position size is much smaller at less than a third of my original Petroch-C4 position. Naturally, I am expecting a worse price tomorrow due to the prior day weakness in HK, but in the worst case scenario (assuming I can execute my personal stop loss without much slippage), I still expect to keep around 90% of my Petroch-CW gains. From my peak gain in total equity in late July, my total gain is now close to double the peak in roughly 3+ months as a result of improved focus on position sizing. Naturally, I am happy with my Petroch-CW gains, but the personal satisfaction of a successful trade with improved position sizing is beyond description.

Good luck in your future trades.

Disclaimer: As usual, trade (buy, hold, sell) at your own risks.