Posted: 3 May 2020
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The Key Investment Lessons
In the first post on The Hatch Fund, I share my investing journey – the ups and the downs – and what I learned from riding through this investment rollercoaster. In the spirit of learning from the past, I took this chance to reflect upon my past investments/trades and have summarized the key takeaways that I believe every investor should always keep in mind:
- Don’t mistake sentiment-driven gains for proper investing. Do your proper due diligence/research.
- Don’t chase the hype, and always weigh the potential upside against downside risks.
- Don’t let recent history cloud your judgment.
- Diversify your portfolio.
- Don’t try too hard to time the market, instead aim to buy quality companies at cheap prices.
- Trade on hypotheses, not on emotions.
- Buy into a position (long/short) and hold it – transaction fees can kill.
- Cut your losses when you do not have a strong reason/hypothesis to hold
Zig when the market zags when you have a strong reason to do so
These lessons were drawn from my mistakes in the past – mistakes that led to a ~40% loss – which led to a change in my course of actions that eventually guided me out of this massive loss. I pen down this article so that my readers can learn from my mistakes, and not have to go through the same calamity as I did. This post is split into 2 articles in the interest of keeping each post shorter. The two articles cover 3 phases of my investment journey – the beginning, the fall, and the recovery. In each phase, I pen down the insights that I have drawn through reflecting on my mistakes and personal experience.
Many of these lessons only became apparent after studying various acclaimed investors and financial authors, such as Ray Dalio, Warren Buffett, and Tobias Carlisle. Most influential of all was Ray Dalio – the founder, co-CIO, and co-Chairman of Bridgewater Associates (the world’s largest hedge fund). His writings (articles and books) and interviews have helped me to understand that the financial market is much more complex than I thought. Most importantly, Ray Dalio taught me the need to stay radically open-minded in accepting mistakes, moving past them, and to continue learning because there is always more that we don’t know than we realise.
Long story short, Ray Dalio inspired me to adopt a hypothesis-driven investment style, which led me out of the massive hole that I dug myself in over the past 2 years, and I highly recommend every investor follow him.
The Beginning – a Streak of Good Luck
Like many others, I was quite clueless as to how the stock markets worked when I first started investing; In fact, many of my initial investment gains, such as the ones listed below, were dumb strokes of luck in hindsight.
- 99% gain on Best World International Limited (SGX:CGN) – a multi-level marketing nutraceutical company that was later halted from trading for an ongoing fraud investigation.
- 9% gain on Delong Holdings – a hot-rolled steel coil manufacturer which turned out to be a very decent company, and was later delisted at 4 times higher than my initial buy in price (unfortunately, I had exited before the delisting offer was made because I hadn’t done enough research to justify holding the stock).
However, having started on the backfoot of such huge gains in a bull market (a period of sustained price increase), I mistook dumb luck for investment ingenuity. Investing seemed like such an easy proposition – just put some money into whatever’s popular and you will get back more in return. It definitely seemed that way in early 2017. But what I wasn’t aware of back then was that in 2017, the Straits Times Index was up 17.8%, the Dow Jones Industrial Average was up 26.7%, and the S&P 500 was up 20.5%. I was just lucky to have invested money at the right time – when the financial market was extremely bullish.
After exiting Best World, I racked up minor losses by investing in Yanlord (a residential, commercial and integrated property developer). Did I know what the Company’s principal activities were? Not at all, all I did was look at analyst reports and buy when the analyst(s) gave ‘BUY’ recommendations. Thinking back, I think many beginners fall into this trap of wanting to profit by doing as little work as possible, and I was no exception. This reflection leads me to the two lessons:
Lesson 1: Don’t mistake sentiment-driven gains for proper investing. Do your proper due diligence (a.k.a. research)
This applies to me, and to those who started investing in the last 2 months or so. Much like my investment in Best World, many stocks have seen recovery from the COVID-19 lows over the past 1-2 months.
If you just started investing, and managed to hop on the bandwagon without doing proper research, I urge you to not mistake luck for proper investing. As you will find out later in this post, my lack of research and proper due diligence (amongst other bad habits) eventually led me to a S$12,000 loss.
Lesson 2: Don’t chase the hype and always weigh the potential upside against downside risks
To give you an example of what I mean, let’s take a look at a highly speculated stock in today’s market, Biolidics [SGX:BLD]. Following the COVID-19 outbreak, healthcare stocks experienced a strong surge in share prices as investors flock towards the main beneficiary of the pandemic. And on 26 March, CGS-CIMB released a ‘BUY’ recommendation for Biolidics, a Singapore-based cancer diagnosis company, at S$0.32.
Just weeks following the release of the analyst report, Biolidics announced that the sale of COVID-19 rapid test kits to a U.S. distributor, Aytu Bioscience. Its share price shot up from ~S$0.20 to S$0.885. At this point, the company has yet to turn profitable but was trading at up to 150x EV/Revenue (I will go through these jargons in subsequent posts). Put simply, the entire company was worth $150 for every dollar of revenue the company made. For comparison, Siemens Healthineers [XTRA:SHL], a healthcare equipment juggernaut, trades at 2.7x EV/Revenue.
Many failed to consider several more fundamental matters, such as Biolidics’ production capacity, the number of test kits Aytu Bioscience will buy from Biolidics, and, most importantly, the profitability of these test kits. After the hype deflated, its share price has now settled at around S$0.40. I can only hope that not many retirees were badly burned in this zero-sum game.
Regardless, the lesson here is to never chase the hype without proper understanding. Even with proper due diligence done, always weigh the potential upside against the downside risks.
The Build-up, the Bad Habit and the Fall
Despite the stumble, by March 2018, my portfolio was up by 18.0% (~S$3,700 gain on S$20,600 of injected capital). At this point, I was holding on to fairly decent companies – AEM Holdings, Guocoland, and Keppel Corporation – and everything was looking rosy and up.
Not long after, AEM’s share price started falling when the U.S. imposed steel and aluminum import tariffs in March 2018. And on 2nd April 2018, China retaliated by imposing tariffs on 128 products. Weeks later, tensions between the U.S. and China escalated, and the U.S. banned businesses from doing business with ZTE (Chinese phone maker). AEM’s key customer, Intel, had a huge portion of their supply chain operating in China, making it extremely vulnerable to red tapes. This exposed AEM to the element of an escalating trade war. Before long, investors started rotating out of the high-risk sectors, like Tech, which negatively impacted the closely linked semiconductor industry.
As logical as these seem, I had not fully taken into account the impact of these trade tensions. At that time AEM formed more than 80% of my portfolio and the recent strong gains led to strong optimism about a fast recovery. However, things played out in a totally different way. The stock price continued tumbling from its all-time high of S$1.87 to S$0.67 in August 2018, and the fear got to me; I sold the bulk of my holdings close to the bottom and had locked in losses of about S$8,000 from selling my shares in AEM at this point. I had not done enough research to give me the confidence to hold on to the stock and ride it through the downturn.
Lesson 3: Don’t let recent history cloud your judgment
As much as we don’t like to admit it, our memories tend to be short. People tend to focus on recent history and project the same trajectory into the future. When times have been good, people think the good times will keep rolling; When times turn for the worse, people foresee the future getting bleaker. This mentality ends up making us behave irrationally, especially when things don’t pan out as expected. We end up selling when prices dip and buying when prices rise.
This again reflects the importance of understanding what is happening around us – how the economy is shaping up, how will the company fare in different scenarios, and so on. Only by keeping abreast with these developments can we move in anticipation of change and not in reaction to it.
Lesson 4: Diversify your portfolio
During the good times, I concentrated most of my eggs in one basket – AEM Holdings. And as things turned south, I twisted a classic finance concept of risk-return to try to justify “high risk, high return”. I had always recognized that taking high risks may not always promise positive returns. But only until recently had I realize that it is possible to have high returns even with a moderate-to-low-risk taken on (asymmetric risk-return).
The beauty of diversification is that companies in different industries are affected by different news, policies, and developments. This is extremely useful because there is much more that we don’t know than we realise. Investing in companies from different industries, with different revenue streams and risk exposures, helps us to minimize losses when we miss out on new developments, which can happen very often.
At the same time that this happened, I picked up a very bad habit. I began trading stocks on contra (buying stocks that can be paid a few days later) in a bid to day trade (buying and selling in quick successions) for some quick profits. In doing so, I further added to my losses:
- More than S$3,000 loss from trades on Venture Corporation;
- S$400 loss from trades on Creative Technology; and
- About S$500 from trades on AEM Holdings.
Why did I trade Venture Corporation and Creative Technology? Because they were extremely volatile stocks (i.e. their share prices changed a lot very quickly). It was the same “high risk, high return” mentality that dug me into a deeper hole.
In early 2019, I had been following business news on Bloomberg, and several other news sources, for a considerable amount of time and I had worked in Investment Banking for months. Despite my lack of knowledge on several subject matters (including macroeconomic policies, business strategy, business risks and the links between the real economy and the financial market), I was extremely arrogant in thinking that I could time the market better than others. I continued selling and buying AEM shares to try to lower the average price I paid. My trades looked a little something like this:
In short, these trades clearly didn’t work in my favor and they added to my losses. I found myself constantly checking the stock prices, which caused a great deal of anxiety and FOMO (fear of missing out). Sitting on the back of massive losses (relatively speaking) made me more desperate in trying to recover the losses as I continued to trade shares in the hopes of making quick profits. As of 30 April 2020, AEM’s share price stands at S$2.45.
Lesson 5: Don’t try too hard to time the market, instead aim to buy quality companies at a cheap price
“Timing the market” means trying to figure out where share prices will bottom out and where they will peak. In other words, it is the concept of buying low and selling high. While I am sure some people can do this with a high degree of accuracy, most of us do not have the knowledge and resources to do this sustainably.
Instead of timing the market, what we should do is to buy quality companies when prices are cheap. But how do we know if prices/valuations are cheap? There are few metrics/ratios that we can look at to understand if a company’s value is high or low. You might have come across some of these in the past – Price-to-earnings, EV/EBITDA, EV/EBIT, etc. – and wondered what they mean.
While I would like to avoid jargon and explain the technicalities in simple terms, I think it pays dividends to learn the jargon rather than avoid them. Much like how a programmer should learn the proper foundations of coding and troubleshooting, instead of copying other people’s codes, we investors should seek to find our own truth based on our analysis. The world of finance is shrouded in jargon, and learning how to navigate through them can be extremely valuable in helping you form your own opinions. However, I will leave these to a separate post.
Lesson 6: Trade on hypotheses, not on emotions
As you can see, trading tends to be like riding an emotional rollercoaster; One that turns people into a gambler-like state. When we trade without a hypothesis, we end up relying on our “gut”, which often ends terribly. So what is a hypothesis-driven investment? Essentially, we form a hypothesis (a proposed explanation) that will help to explain why the company should be worth more than its current valuation.
For example, many S-REITs are currently trading below 1x of their net asset value (what you own minus what you have to pay for). The hypothesis can be as simple as “REITs will trade at 1x NAV in the post-COVID world”. What we do next is to try and break down the hypothesis into smaller components to address how we get there. For a retail REIT (those that own and manage shopping malls), we can consider along the dimensions of retail footfall, the survivability of tenants through the periods of lockdown, and the government policies enacted to help REITs tide through. These will ultimately affect the underlying performance of the REITs either positively or negatively. Based on a combination of these components, we then test if our initial hypothesis still holds.
We can also do the opposite and hypothesize that real estate prices will fall. And if that is the case, we then have to find out what events in the past caused real estate prices to fall, which happened in almost every single major economic downturn in the past.
By weighing the upside potential against the downside risks, we make better decisions. As new developments come up, we can compare it to the components of our initial hypothesis and decide if our explanation is still valid in the new world.
From the point that I locked in my losses on AEM (August 2018), I continued to rack up losses from the contra trades and my AEM trades. Unbeknownst to me was that a silent killer was lurking in the background – transaction fees. From January 2018 to January 2019, I had made close to 50 trades. Each trade had cost me slightly over S$25 per leg (referring to the buying and selling of shares). As I bought and sold in a bid to recoup my losses, I had unknowingly incurred more than S$1,000 of transaction costs (brokerage and clearing fees).
Lesson 7: Buy into a position (long/short) and hold it
While day trading may seem like a ‘cool’ or ‘trendy’ thing to do, it is very unpredictable. Often, we end up losing a huge chunk of our money to brokers without even knowing it. What I did in the 2018 – 2019 period was a prime example of that.
This again points back to the perks of having a hypothesis-driven investment style. Rather than following the noise in the market (inaccurate, sentiment-driven fluctuations), having a hypothesis gives greater confidence in holding onto our positions. We only trade when our hypothesis is eventually proven to be true, or when new developments have arisen and invalidated our hypothesis.
e.g. Tenants started to default on payments (based on the previous retail REIT example)