Companies with Durable Competitive Advantages

The Sage of Omaha has emphasised time and again to only invest in companies that has a durable competitive advantage. The phrase “durability” can be subjective so to clear the air, a durable competitive advantage is an advantage that should at least last decades, if not indefinitely, not one that will last a couple of years or less. Companies that have short-term competitive advantages may do well for a year or two but without durability, any success will be short-lived. Beside Mr Buffet's sublime investment reputation, 3 key reasons come to mind on why we should heed his advise:

• It's hard to predict how long a company with a non-durable competitive advantage can milk her cash cow before the curtain falls. If you buy such a share, you may well make a quick buck. However, it's very likely that you will sell too early or too late and not optimise your profit. The more you repeat the cycle, the higher the loss in profits.

• Many cases, such companies may not even have enough time to translate their competitive advantage into profit before being ousted by competitors. If the share is not sold by that time, whatever paper profits you may have made can easily turn into losses.

• Due to the nature of companies without a durable competitive advantage, their shares should naturally be sold before the competitive advantage is lost. After selling, you will have to search for new berths to park your funds. In other words, you have to repeatedly look for short to mid-term investments. Buying and selling of shares involves brokerage fees, which does not amount to much for small volume transactions but will mount up quite fast if you carry out a hundred or more transactions every year. More importantly, sniffing out a good share is a time-consuming process.

Isn't it simply better to search for a company which you can invest indefinitely? How do we find these gems? One of the key signs to spotting a company that has a durable competitive advantage is extremely intuitive - a strong branding. Such companies tend to be one of the market leaders in their industry if not the market leader. Consumer brands, such as Coke and McDonald's, are well-known to most people on the planet and evidently possesses a very durable competitive advantage. Even billionaires would not think to start a business competing against these behemoths.

Non-consumer brands may not be as well-known to the general public but can be easily identified by people in the industry. Just ask any industry person to name the top companies in their sector and the names will generally gravitate towards the same few. Employees of shipping companies will not miss out Maersk or Hapag-Lloyd.

Patents, government regulations or even long-term contracts can also bestow upon a company a durable competitive edge. Pfizer's patents in relation to Viagra allowed it to monopolise and dominate the male sexual dysfunction market. Similarly, China's protectionist measures enabled Baidu to become the top search engine in China. The growth of Singtel into Southeast Asia's top telco also did not come about by chance. Singtel monopolised the Singapore market until 1997, before the local telecommunications sector was liberalised. By that time, Singtel has flourished enough to acquire stakes in other telco companies around the region.

Quantitatively, a company with a durable competitive advantage should have one of the largest slice of the market. Its operating margin (operating margin is the revenue remaining after paying all operating expenses, expressed as a percentage) will be higher than its corresponding industry's average. Such companies tend to invest a minimal amount into research and development, and as a result, are likely to have a relatively higher cash flow. A high cash flow translates to a high chance of dividends. And dividends are great for value investors as that is essentially how we get money back from our investment!

January Property Cooling Measures Pack a Punch!

“TGIF”, I was thinking while gazing at my lovely chicken dinner when my handphone sang a little tune. I took a look at the SMS and learnt my lesson to not ever bring the phone to the dining table. Friday's slew of property cooling measures, unlike the previous few, strongly indicated that the Government is not happy with the pace that property prices are moving up. In fact, my gut is telling me the Government will not be happy until property prices undergo a correction.

The following is a summary of the key residential property measures and my two cents in italics.

• Reduction in the Debt Servicing Ratio to 30% if borrowing from financial institutions — a whooping 20% reduction. For loans granted by HDB, the Mortgage Servicing Ratio will also be reduced from 40% to 35%.
  
• Permanent Residents (PRs) who own a HDB flat will be disallowed from subletting their whole flat.
  
• PRs who own a HDB flat must sell their flat within six months of purchasing a private residential property in Singapore.

• HDB flats are for own-stay and certainly not for PRs to invest in. For Singaporeans, you can still keep one HDB flat for invesment but make sure your cashflow is good.

• Additional Buyer’s Stamp Duty (ABSD) rates will be raised between five and seven percentage points across the board.
  
• The ABSD will be imposed on PRs purchasing their first residential property and on Singaporeans purchasing their second residential property.

Citizenship	ABSD Rate on 1st Purchase	ABSD Rate on 2nd Purchase	ABSD Rate on 3rd & Subsequent Purchase
Singapore Citizens	Existing: NA Revised: NA	Existing: NA Revised: 7%	Existing: 3% Revised: 10%
Permanent Residents	Existing: NA Revised: 5%	Existing: 3% Revised: 10%	Existing: 3% Revised: 10%
Foreigners and non-individuals (corporate entities)	Existing: 10% Revised: 15%	Existing: 10% Revised: 15%	Existing: 10% Revised: 15%

• Loan-to-Value limits on housing loans granted by financial institutions will be tightened for individuals who already have at least one outstanding loan, as well as to non-individuals such as companies.
  
• Besides tighter Loan-to-Value limits, the minimum cash down payment for individuals applying for a second or subsequent housing loan will also be raised from 10% to 25%.

1st    Housing Loan

2nd Housing Loan

From 3rd Housing Loan

LTV Limit	Existing Rules 80%; or 60% if the loan tenure is more than 30 years or extends past age 65 Revised Rules No change	Existing Rules 60%; or 40% if the loan tenure is more than 30 years or extends past age 65 Revised Rules 50%; or 30% if the loan tenure is more than 30 years or extends past age 65	Existing Rules 60%; or 40% if the loan tenure is more than 30 years or extends past age 65 Revised Rules 40%; or 20% if the loan tenure is more than 30 years or extends past age 65
Minimum Cash Down Payment	Existing Rules 5% (for LTV of 80%) 10% (for LTV of 60%) Revised Rules No change	Existing Rules 10% Revised Rules 25%	Existing Rules 10% Revised Rules 25%
Non-Individual Borrowers	Existing LTV Limit 40% Revised LTV Limit 20%

• Residential property investing is only for the very rich – millionaries can own 2 properties but for 3 or more, millionaires do not make the cut. That is only for the multi-millionaires.
• For those who still harbour the thought of making a quick buck (e.g. speculators, specu-vestors and the like) off property, the death knell has struck. Adieu speculators.

3 Things You can do for the Impoverished

It's easy to think that there shouldn't be any Singaporean living in poverty, especially with the recent Straits Times articles reporting of a $3,000 per month dish-washing job, monthly salaries of $5,000 for lorry drivers and a taxi driver who earns $7,000 a month.

The articles are misleading however. The taxi driver has since clarified that he only earned $7,000 once and his usual remuneration is $4,000 to $5000. After some sleuthing, I also discovered that $5,000 as a lorry driver is the exception rather than the norm and even then, similar to a $5,000 a month taxi driver, involves very long hours of work. For the dish-washing job, I had the chance to speak with an NTUC Union staff, who actually put forward many workers for the position subsequent to the newspaper article: not a single one got the job.

While I do believe that most people should be able to earn a decent living in Singapore, there are unfortunately some people who fall through the cracks. Many people who face constant financial difficulties are stuck in low-wage jobs, jobs that pay around $1,000 or less, as they do not possess the skills to get a higher pay one. The majority are unable to converse in English, let alone reading or writing in English. They certainly wouldn't be able to understand this article, which is where you come in. Here are 3 things you can do for these folks in 2013!

Encourage Skills Upgrading

There are a number of Continuing Education & Training (CET) Centres who offer training courses that are 90% - 95% subsidised by the Government (click here for the list of centres). Notably, Mendaki offers a 45-hour conversational English course at just $15 after subsidy. The course is held during weekends and the exact timing depends on the participants.

Some people may find it hard to attend a course, especially when they are already so tired from their struggles trying to make ends meet. Others think they are simply too old to learn new things. Encouragement and support from friends go a long way. On a side note, I used to have a 72 year-old course-mate so one can never be too old to learn!

Sell Flat or Relocate

Some people who are living in poverty may actually be asset-rich but cash-poor. Instead of living hand to mouth, they can sell their asset, free up some cash and downgrade by renting or buying a smaller flat.

These folks are probably not aware, but with HDB flat prices at an all-time high, it's a good time for them to sell their HDB flats soon. Alternatively, cash-strapped elderly (55 and above) who own flats can also sell the tail end of their HDB lease back to the Government under the Lease Buyback Scheme (LBS). Just last Thursday, the Government announced enhancements to the LBS together with the Silver Housing Bonus (elderly home-owners basically get $20,000 cash for downgrading). The improved schemes will be implemented from 1 February 2013 so the best time for these elderly to sell will be shortly after the implementation date. The public can call 1800 555 6363 for more information on these schemes.

For poor and needy Singaporeans, who do not own a flat, monthly rental of a 2-room HDB for poor Singaporeans can be as low as $50 - you can find more details on subsidised HDB rental flats here.

Seek Financial Assistance

For people without flats, financial assistance plans aplenty is a bit of a double-edged sword. Finding the appropriate financial aid may not be easy. I found this out first hand from asking about schemes for a friend, and my friend's case is supposed to be pretty straightforward. Regardless, help is there if you look close enough.

A first step would be to call the Community Chest hotline at 1800 210 2600. Community Chest will then be able to point you to specific charities or government bodies that may be able to offer assistance. Individual Family Service Centres also have schemes that can be found on their respective websites. The applicant should be completely honest when applying for aid as non-disclosure can lead to a lengthy approval process and even jeopardise their chances. For low-wage workers, the Workfare Income Supplement (WIS) Scheme (details can be found here) is a decent financial assistance scheme.

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.