The 2 Cornerstones of Value Investing

Some friends tell me that they feel a bit overwhelmed with value investing as it seems too complicated. In reality, the basics of value investing are pretty straightforward. We just need to have an understanding of the following 2 cornerstones.

Value for Money
Value for money is essentially about buying into undervalued companies. For example if a company is intrinsically worth 50 million dollars and you can purchase 10% of the company from the stock market for less than 5 million dollars, you are buying into an undervalued company. The steeper the discount, the greater the value.

Why would a company trade at a lower price than its fair value? Primarily because assessing the fair value of a company can be subjective. Even with many objective numbers to refer to (e.g. PE ratios, ROI etc), stock analysts' views on a stock can differ greatly. The key to mastering this cornerstone is to learn to accurately assess the value of a company.


Durable Competitive Advantage
Fundamental to value investing, is the belief that one cannot accurately predict short term fluctuations in the stock market. Value investing is essentially about investing for the long haul. As such, simply buying into an undervalued company is not good enough. The company must also have a durable competitive advantage. Basically, we don't want to buy into a company that is only going to be the flavour of the month. What value investors want, is a company that will still be a market leader many years down the road.


Paraphrasing what my old fluid mechanics lecturer, Professor Collins, said with relation to Bernoulli's principle, when a value investor dies and his or her brain is dissected, we should be able to find these 2 cornerstones imprinted there!

Latest Property Cooling Measure – Will Prices Fall?

MAS announced new property cooling measures on 5 October that took the market by surprise. Will this herald the start of a correction in property prices? For the uninitiated, the following are the new restrictions:

• Loan tenures of more than 35 years will no longer be allowed
• For loan tenures that exceed 30 years or if the the loan period extends over 65 years old for the borrower
  • maximum loan-to-value (LTV) will be 60% for people with no existing home loan
  • maximum LTV will be 40% for people with one or more home loans
    
    

Let's start off by taking a look at the monthly instalment figures for a loan of $800,000.

Interest Rate (%)	Monthly Instalment ($) - 20 yrs	Monthly Instalment ($) - 25 yrs	Monthly Instalment ($) - 30 yrs	Monthly Instalment ($) - 35 yrs
1	3679	3015	2573	2258
1.5	3860	3199	2761	2449
2	4047	3391	2957	2650
2.5	4239	3589	3161	2860
3	4437	3794	3373	3079
3.5	4640	4005	3592	3306

Depending on the interest rate, the difference between the monthly instalment for a 30 and 35 years loan is around 10% to 15%. This will increase by about 2% for every subsequent 5 years reduction in the loan tenure. e.g. difference in monthly instalment between 30 and 25 years tenure is around 12% to 17% and 25 to 20 years, 14% to 19%. The percentage difference is more or less the same, regardless of the loan amount (don't take my word for it - use this home loan tool for a look at the figures).

For people who find it hard to fork out the additional monthly instalment, they have the option of buying cheaper properties to bring down the monthly instalment. Folks with enough money to take up loans with lower LTV can also proceed with their purchases and opt for a longer loan tenure if they wish to. And the new measure will have practically no impact for citizens buying HDB flats and taking up the HDB concessionary loan, as the maximum tenure of a HDB concessionary loan was and still is 30 years or up to 65 years, whichever is shorter.

So who are the people affected? Essentially people who will face difficulty servicing their monthly instalments if they cannot opt for a monthly instalment that is past the retirement age of 65. This group of property buyers are treading on thin ice for a couple of reasons. Even though signs are pointing to a later retirement age down the road and the property may also fetch a decent rental income, there is no certainty that this will happen. Counting your eggs before they hatch is never prudent. Furthermore, the artificially low interest rate environment is not here to stay.

Referring back to the table above, when interest rate increases, the monthy instalment can quite easily increase by more than 10%. What will happen if this group of people are allowed to proceed with their purchases and interest rate increases? They will be forced to sell their properties if they cannot service the monthly instalment. This in turn can cause turmoil in the property market and unncessary distress to these property owners. The number of people in this group are few and far in between however, and MAS appears to be simply exercising prudence in the matter. How could they not when Minister Khaw Boon Wan has communicated clearly to the press that a 50-year housing loan is a gimmick.

If previous market reaction to MAS's property cooling measures is anything to go by, property volumes will be subdued for a few months and prices may go down slightly. But judging by how this measure is not going to affect most people, it alone is not going to cause any long term impact on property transaction volumes and prices. In fact, mass market properties is likely to face greater demand as there will be more potential buyers with tighter purse strings. So the answer to the earlier question “Will this herald the start of a correction in property prices?” - highly unlikely.